Mortgage Rates Are Soaring and Buyer Demand Is Dropping. Here's Why That Could Be Good News

While higher rates aren't a good thing, they could cause some positive changes.

From mid-2020 through the end of 2021, home buyers had access to extremely low mortgage rates. And those low rates came in very handy at a time when home prices were soaring.

Currently, home prices are still extremely elevated -- but mortgage rates have been rising since the start of 2022. And at this point, while they're still fairly competitive, rates aren't nearly as low as they were last year and during the latter part of 2020.

Not surprisingly, higher rates have caused mortgage volume to slide. Last week, mortgage applications to purchase a home were 8% lower than they were the same week one year ago, according to the Mortgage Bankers Association. And refinance volume dropped substantially, falling 49% compared to the same time frame last year.

Now at first glance, higher mortgage rates might seem like a bad thing for home buyers. But actually, they could have one very positive effect on the housing market.

Will higher mortgage rates drive home prices downward?

We're already seeing less mortgage demand this year as rates rise. If that trend continues and buyer demand wanes to a significant degree, it should result in a drop in home prices. And that could end up being a good thing for buyers.

Plus, if more potential buyers drop out of the market, those who stay in it will face less competition. That means fewer bidding wars, which are notorious for driving home prices up.

Will mortgage rates continue to climb?

There's reason to believe they will. For one thing, rates have been sitting at such low levels since mid-2020 that they were apt to start rising.

What's more, the Federal Reserve has its own rate hikes planned for 2022. Now the Fed doesn't establish mortgage rates. In fact, it doesn't set any consumer interest rates. But when the Fed raises short-term borrowing rates among banks, consumer interest rates tend to follow a similar pattern. And for that reason alone, mortgage rates could continue to climb as 2022 moves along.

Now that doesn't mean we won't see any temporary dips. Just last week, home buyers got a bit of a reprieve as mortgage rates dropped pretty substantially. But they're already back up this week, and it wouldn't be surprising to see that trend continue well into the year.

So where does that leave buyers? If home prices start dropping, that may be more than enough to compensate for higher mortgage rates (just as for much of last year, lower mortgage rates helped compensate for higher home prices). And so those who are in a strong position to purchase a home may want to stick with plans to do so in 2022.

Prospective buyers can also set themselves up to snag the lowest mortgage rates possible. That means shopping around with several mortgage lenders, boosting their credit, and eliminating as much existing debt as they can. Even with mortgage rates rising, it's possible to snag a competitive rate on a home loan -- but the lowest rates will ultimately be reserved for the strongest borrowing candidates.