estimate of how sensitive housing prices are to interest rates , assuming that all the other costs and benefits to
housing don’t change with interest rates.
Many factors other than interest rates also influence housing prices. For example, the demand for housing would
be greater with stronger household income growth, increased population through immigration, or a preference
for fewer people living in each household. Conversely, the supply of housing would be lower than expected if
construction turns out to be constrained in some way. These factors would all lead to stronger demand, or
weaker supply, for housing and so housing prices (and rents) would not fall as much as implied by interest rates
acting in isolation.
The impact of interest rates on housing prices importantly depends not only by how much they change, but for
how long. If interest rates were assumed to be 200 basis points higher forever then this model suggests that
housing prices would end up being around 30 per cent lower than if interest rates had not changed. It is notable
that these estimates based on historical data show that the change in housing prices occurs relatively slowly,
certainly more slowly than for the prices of financial assets. The model also suggests that if interest rates reverted
to their initial level after that two-year period, the interest rate effect on prices would be expected to eventually
unwind.
Offset to higher mortgage interest charges from lower housing prices
As I mentioned, an increase in interest rates increases the required repayments on a mortgage. In other words,
rising interest rates increase the cost of owning a home. This effect is more or less immediate – for borrowers on
variable rate loans it likely occurs within one or maybe out to three months. Over time, however, the increase in
interest rates works to reduce the demand for housing and so housing prices decline. This means that a
household would need a smaller mortgage to purchase a first home or if they were upgrading.
Estimates suggest the net effect is that mortgage payments for new buyers would be higher for about two years
as a result of higher interest rates.
[5]
But after that, the declines in housing prices and mortgage size begin to
dominate. This exercise obviously abstracts from the many other factors influencing interest rates and housing
prices, but it suggests that because higher interest rates reduce housing prices and so mortgage sizes, mortgage
payments for new borrowers could ultimately be lower than if interest rates had not increased.
A regional look at housing interest sensitivity
The sensitivity of housing prices to interest rates could also differ regionally or for different types of housing.
Some of my colleagues at the RBA studied this and found that the prices of different types of housing could have
different responses to changes in interest rates.
[6]
They found evidence that, controlling for other factors, interest rates can have larger effects on housing prices in
locations where the supply of housing is less flexible, mortgage debt is higher, there are more investors and
incomes are higher. These estimates do not indicate that these factors cause housing prices to be more
responsive to changes in interest rates, but they do highlight that the sensitivity of housing prices to interest
rates is not going to be uniform across the country.
What’s more, they find that housing prices in the most expensive areas are the most sensitive to interest rate
changes. This matches the observation that housing prices in more expensive locations are more cyclical
(Graph 4). Similarly, there is some evidence that detached houses are more sensitive to changes in interest rates
than apartments.
[7]
It appears that the limited supply of available zoned land partly explains this result. Overall
this indicates that an increase in interest rates narrows the distribution of housing wealth since more expensive
properties experience a larger fall in prices. But their results suggest that this distributional effect is temporary as
the effects of interest rates on more expensive and cheaper properties converge over time.
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