Strategic Homebuying: Capitalizing on Peak Mortgage Rates for Long-Term Gain

Some of the advice that every victim in a horror movie might give a prospective home buyer when mortgage rates rise to high levels is to “Stay away from the woods” (a.k.a. don’t talk to anyone trying to sell you a home), and “don’t run up the stairs” (a.k.a. don’t rush to make an offer on a house). The good news is that purchasing a home can be significantly less treacherous than what a horror victim goes through in a scary movie.

Still, the natural reaction for some prospective home buyers is to run away from the market and refuse to talk to anyone who wishes to discuss any new houses listed on the market until mortgage rates come down to levels that make such purchases more affordable!

A typical $500k home (with a 20% down payment and financed loan amount of $400k) at an average 30-year mortgage rate of 2.84% (in August 2021) generates a monthly payment of $1,652.00 (excluding taxes and PMI). Imagine the sticker shock of that transaction in October 2023, when the average monthly mortgage rate rose to 7.62%! At that higher rate, the monthly payment would increase to $2,830!

What Options Are Available to Prospective Home Buyers When This Happens?

First, one should realize that a home buyer faces more favorable options than choosing between entering the woods or running up the stairs. The choices are buying a new home or a previously built one. Our analysis find that home prices tend to decline as mortgage rates rise, but the decline was steeper for new homes. Specifically, the median price of a new home exhibited a 47% larger negative correlation. That means purchasing a new home may become attractive when mortgage rates rise to nosebleed levels.

For example, the median sales price of new homes (according to the U.S. Census Bureau) dropped 16.5% from October 2022 to October 2023, when the average monthly mortgage rate peaked at 7.62%, which amounted to an impressive $81.9k price reduction!

Source: The U.S. Census Bureau and Freddie Mac

In contrast, the median sales price of an existing home declined by 4.5% from its peak in June 2023 through October 2023. With the additional decline in November 2023, prices fell by 5.6%, or $22,400. This decline was 27.4% of the drop observed for new homes, making purchasing a new home compelling when mortgage rates surge!

Source: The National Association of Realtors, Federal Reserve Bank of St. Louis, and Freddie Mac

What Benefits Can Home Buyers Expect from Entering the Market at Peak Mortgage Rates?

As previously computed, if a prospective homeowner bought a new median sales-priced home at the peak of mortgage rates, they would have enjoyed a price reduction of $81.9k from the previous price peak! Although the decrease was about a third (or $26.2k) for an existing home, the savings are still substantial.

Next, using our conservative assumption that the 30-year mortgage rate will drop by an additional 108 basis points by 2025, the prospective homebuyer, after refinancing, would reduce their monthly mortgage payments by over $400.00 on a median-priced new home. To some, this sounds great until one considers the costs of refinancing, which will cost $12k on average and take about 2.4 years to recoup. That means if they sell their house before this breakeven period, refinancing at a lower rate would not be advisable.

The good news is that if the homebuyer bought the home at peak mortgage rates, they would have saved $81.9k or $26.2k for a median sales-priced new or existing home, respectively. Such savings are sharply higher than the cost of refinancing. Secondly, if history serves as a guide, the negative correlation of home prices with mortgage interest rates suggests that as mortgage rates decline, it will boost prices as greater affordability boosts demand!

Summary and Concluding Thoughts

Although some might think that purchasing a home during a period of high mortgage rates can be as scary as a victim's experience in a horror movie, our analysis finds that prospective homebuyers can navigate the process to their advantage.

Home prices tend to decline when mortgage rates rise, allowing prospective buyers to buy a house at a significant discount. Although the scary high mortgage rates may discourage some buyers, history has shown that above-normal mortgage rates don’t last forever. They will eventually go down and to normalized levels. At present, financial markets are projecting a 150-basis point cut in the federal funds rate by the end of 2024, and we project that 80 to 85 of this decline could spill over into the 30-year mortgage interest rates. Although some of this projection is already reflected in the latest mortgage rate readings, we project that the Federal Reserve’s federal funds rate could drop another 50 to 100 basis points in 2025, which is not reflected in current mortgage rates.

Homeowners need mortgage rates to drop by at least 1.0% to make refinancing a profitable strategy due to its transaction costs. Fortunately, purchasing a home when interest rates are high may yield a sizable discount on the home's purchase price that may exceed the cost of refinancing, which can take up to 2.4 years to break even. Finally, as a bonus, when interest rates begin to decline, we should see that the negative correlation between home prices and mortgage interest rates will translate into price appreciation on their purchased homes!