Home Prices Are Up Nearly 20% Year Over Year. Will Rising Mortgage Rates Bring Them Down?

Buyers need relief -- but will that happen?

It's hardly a secret that homes have been expensive since the latter part of 2020. But the extent to which prices have risen may surprise you.

In February, home prices increased 19.8% on a year-over-year basis, according to the S&P CoreLogic Case-Shiller national home price index. That's an increase from January's annual home price gains of 19.1%. 

Clearly, higher home prices are a bad thing for buyers -- especially at a time when mortgage rates have also gotten expensive. But if mortgage rates keep climbing, which is likely to happen, then buyers may actually start to get some relief on the home price front.

Will rising mortgage rates cool the housing market off?

A big reason home prices have sustained such high levels is that buyer demand has been strong since the second half of 2020. But if borrowing becomes prohibitively expensive, buyers might start to pull out of the market. And once demand wanes, home prices should start to come down to more moderate levels.

This isn't to say home buyers -- or sellers -- should gear up for a real estate market crash. Rather, we could see a gradual decline in home prices as buyers put their plans on hold and wait for more affordable opportunities.

Now to be clear, there's no guarantee that mortgage rates will continue to rise this year. But that's likely to happen for one big reason. 

The Federal Reserve has plans to implement several hikes of its federal funds rate this year. As that happens, consumer interest rates are likely to rise as well. Whether mortgage rates rise as rapidly as they've done over the past four months is yet to be determined. But given that borrowing is already expensive, buyers may not be willing to bear much higher rates.

Will buying a home be feasible for you this year?

If you're on a tight budget, it may not be. Even if home prices come down a bit later on in the year, higher mortgage rates could offset those discounts, leaving you in the same position you're in today. On the other hand, if you have more financial flexibility, you may find that homes are more affordable later on in the year -- especially if prices come down and mortgage rates don't end up rising all that much. 

Inventory is also apt to play a role in affordability. Right now, the housing market lacks inventory in a serious way. If more sellers decide to list this year, that could also help drive home prices downward.

Now if you're a cash buyer, you won't have to concern yourself with the direction mortgage rates go in. In that case, all you really need to do is track home price gains and see how those numbers shake out.

Either way, though, 2022 could end up being a challenging year to buy a home from start to finish. That's something to keep in mind whether you're planning to finance a home with a mortgage or empty out your bank account to purchase one in cash.