How Interest Rates Affect the Housing Industry

Interest rates in the United States are determined by a number of factors, including the actions of the U.S. Federal Reserve, the health of the economy and the rate at which people are saving money. Given that most home sales are financed through the borrowing of money in the form of mortgages, the housing industry is profoundly affected by changes to these rates.

Function

Interest rates are the rates at which money can be borrowed for a set period of time. The higher the rate, the more money a borrower must pay in the form of interest on the loan. The U.S. Federal Reserve sets a rate at which it lends money to banks and other financial institutions, which in turn affects the rate at which they lend to businesses and individuals, such as people seeking a mortgage.

Significance

Generally, when the interest rate is lower, people are more likely to borrow money, as doing so will cost them less than at another time. Conversely, when the interest rate is higher, borrowing becomes more expensive and slows. This principle applies to loans that come in the form of mortgages. When interest rates are lower, people are generally more willing to take out a mortgage than when rates are higher.

Effects

When mortgage rates are lower, this makes the purchasing of a home more affordable. Consequently, the sales of homes rise as more consumers are able to take out a low-cost loan. Consumers with existing mortgages may attempt to re-finance their mortgage, meaning they trade their current loan for another, cheaper one. In periods of low interest rates, more houses are often built as demand rises, and development companies are able to borrow money at a cheaper rate to finance the construction.

Considerations

Although the cost of mortgages is closely tied to the interest rate, the price at which homes are sold does not always appear in direct correlation. While low interest rates can raise demand for houses, pushing up the prices of houses, if the price gets too high, demand can cool, causing house prices to plummet.

Adjustable-Rate Mortgages

Not all mortgage rates are fixed at the time that the loan is taken out. With an adjustable-rate mortgage, the interest rate of the loan varies with prevailing interest rates and may change as often as every month. Most adjustable-rate mortgages have their rates tied to an index of financial securities, one that changes with the movement of the market. During the financial crisis of 2008, many homeowners faced foreclosure as the rates on their mortgages rose unexpectedly and they could not make their payments.

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