Because higher mortgage rates make it more expensive to borrow, home prices must fall and sales must slow when rates rise, right? The truth is, there is only a modest relationship between home prices and mortgage rates. Therefore, even if rates rise by 50 or more basis points in 2021 (an increase we do not expect), the impact on the market is likely to be very small. Other factors, especially the overall condition of the economy and the level of supply, will be more important to the performance of the housing market.

Mortgage Rates Are Still Low

According to Freddie Mac, the average 30-year fixed-rate mortgage rate was 2.72% during the last week of November. Mortgage rates have been below 3% for 18 consecutive weeks. The weekly average 30-year fixed-rate mortgage rate has hit historic lows more than a dozen times over the past few months.

Low rates have fueled a surge of purchase and refinance applications. The Mortgage Bankers Association is reporting that mortgage origination volume will be higher in 2020 than in any year since 2003.

The housing market continues to boom in light of strong demand and low rates. Nationally, sales of existing homes were up 26.6% in October and new home sales were up by 41.5%. In Virginia, there was a total of 13,424 home sales statewide in October, up 28.3% compared to a year earlier. Home prices continue to rise, with the median sales price statewide in Virginia up by double-digit rates for the 3rd consecutive month.

Why Mortgage Rates Rise

Mortgage rates typically move along with the yield on the 10-year Treasury note. Growing optimism about the economic recovery can push both measures up. Mortgage rates tend to rise when economic conditions are improving, when unemployment is low, when wages are rising, and when overall consumer confidence is high.

As a result, even if rates rise, other positive economic trends support a strong housing market. During good economic times, individuals and families are better able to afford to buy a home and may be more willing to take out a larger mortgage if they feel secure in their economic situations.

How Rising Rates Have Affected Home Prices in the Past

The National Association of REALTORS®, Mortgage Bankers Association, and National Association of Home Builders, along with Fannie Mae and Freddie Mac, are all projecting mortgage rates will remain low, rising only slightly, through the end of 2021. Virginia REALTORS® forecasts indicate the 30-year fixed rate mortgage rate will rise by 30 basis points, ending 2021 at 3.2%.

Nationally, a rise in mortgage rates has only modestly impacted home prices and sales transactions in the past. Looking back at rate increases in 2018 can shed light on how future increases might affect Virginia’s housing market.

In the 2nd half of 2018, the average 30-year fixed-rate mortgage rate was between 50 and 100 basis points higher than during the same period a year earlier. For example, the average mortgage rate in May 2018 was 4.59%, compared to an average rate of 4.01% in May 2017, an increase of 57.6 basis points.

Comparing monthly sales data from 2018 (when rates were higher) to 2017 monthly sales data (when rates were lower) shows a minimal softening in the housing market. In May 2018, the number of monthly home sales was up only 1% compared to May 2017; but in June, monthly sales were lower than a year earlier. The biggest drop in sales was in September 2018, when the average 30-year mortgage rate was 82.3 basis points higher than a year earlier and sales were down by 9%.

While the number of transactions may have been slightly lower when rates were higher, home prices continued to climb by between 2 and 3 percent in 2018, despite rising mortgage rates.

Between 2018 and 2019, mortgage rates began declining by between 50 and 100 basis points, which lets us look at what happens in the market when rates are falling. Monthly home sales were generally, but not always, higher in 2019 compared to 2018 as rates declined. Home price appreciation was stronger between 2018 and 2019, with prices up by between 3 and 6 percent.

Inventory a Bigger Factor than Mortgage Rates in 2021

In the past, rising mortgage rates were associated with only slightly slower home price growth. Home prices continued to rise, just at a slower rate. In the current housing market, however, underlying demand and supply fundamentals are more important than movements in mortgage rates for supporting a strong housing market and robust price growth.

A persistent lack of inventory will be the main factor that will keep pushing prices up in 2021. The number of homes available for sale has been falling for years, but the COVID-19 pandemic has accelerated the decline. At the end of October, the number of active listings on the market statewide in Virginia was just half the level that was available at the end of October 2017.

The demand for home ownership will remain strong relative to the very limited supply, and home prices will continue to rise. Mortgage rates will only increase slightly in 2021 and will not inhibit overall market conditions. However, modestly higher rates and rising prices will impact affordability, making it more challenging for some buyers, particularly first-time homebuyers.