Waiting for Real Estate Prices to Fall Before Buying? Here's Why That May Not Be a Good Idea

It's hard to deny the shifts taking place in the real estate market. Lower demand due to rising interest rates and higher inventory as sellers try to cash in on record-high home prices is cooling the flame behind the red-hot sellers' market.

More and more sellers are reducing their prices, and a growing number of transactions are falling apart due to rising rates making homes less affordable. Many believe falling prices are sure to come and are waiting to buy. But here's why waiting may not be a good idea.

Image source: Getty Images.

Interest rates matter more than you think

Most buyers are fixated on the home's price. It is an important figure that carries a lot of weight when getting a home loan, but interest rates are an equally important factor to consider. Since mortgages are repaid with interest, how much you pay over the life of the loan is determined by the mortgage rate you receive. The lower the rate, the less you pay.

Right now, rates are rising, with no hard stop defined in the future. Buyers waiting for prices to fall could end up paying more in the long run because of the higher interest rate. For example, if you were to get a $393,500 fixed-rate, 30-year mortgage at 5.5% interest -- which is in line with today's rates and the median home price, according to Redfin -- the loan would cost you $804,330 in total after accounting for interest over the life of the loan.

Now, let's say prices fall 6% (an unlikely event we'll talk about shortly), but rates increase by 1%. A loan for $370,000 would then total $841,914 over 30 years, meaning you would pay $38,000 on the loan, despite a $23,500 decrease in the purchase price.

Data source: Redfin. Calculations and chart by author.

As you can see in the chart above, there is a point where a purchase price can drop low enough to offset a higher interest rate. However, there's reason to believe prices aren't going to drop dramatically enough to offset the difference -- at least not in the near future.

Prices will likely continue to grow in most markets

The cooling housing market doesn't necessarily mean prices will fall suddenly. It simply means the rate of growth will slow. From April 2021 to April 2022, home prices rose by 20%, which is nowhere near the norm.

Now that rates are rising and inventory is slowing, there's slightly less demand and less competition, meaning real estate inflation should level out closer to historic levels. Over the last 30 years, home prices have grown annually by around 9.8%; however, many economists believe a 4% to 5% growth in home prices is a healthy rate. CoreLogic is projecting a 5% growth rate over the next year -- not a loss in home value.

A recent Redfin report found that the median sales price for the four weeks ending July 10th was down 0.07% from the June 2022 peak. It's definitely a positive sign if you are waiting for lower pricing, but a less-than-1% change month over month won't be enough to offset rising interest rates.

Based on the example above, you would need at least an 11% change in pricing to offset a 1% rate increase. Given that the Fed is expected to raise rates further, there's a good chance that interest rates could climb above 6.5% over the next year. Not to mention lending could tighten in the near future. If we enter a recession -- something many believe is coming -- lending is usually restricted, making it harder for some to get a loan.

Buy now or wait?

All in all, there are many unknown variables that could make buying real estate more expensive and challenging in the near future. If you have the funds and are looking to purchase a home or an investment property today, doing it now may be a better investment in the long run.

However, if you have the flexibility to wait and are hopeful that prices will fall and rates won't rise too high too quickly, it could pay off to wait. Just remember there's no guarantee pricing will come crashing down as hoped.