Interest rates are rising again, what will house prices do?

Central banks do not want to raise interest rates yet, but market interest rates continue to rise. Investors are demanding higher interest rates due to inflation, with the result that interest rates on long-term government bonds are rising rapidly. For example, until recently the interest rates on government bonds of the Netherlands and Germany were still negative, they are now at 0,37% and 0,22%. And that has consequences for the housing market, because mortgage interest rates generally follow the interest rate on long-term government bonds.

New figures from Van Bruggen Advisory Group show that mortgage interest rates are also starting to rise again in the Netherlands. The graph below shows the development of the capital market interest rate, compared to the average mortgage interest rate for 10 years fixed with national mortgage guarantee (NHG). As you can see, mortgage rates follow market rates with a lag. This means that interest rates could rise even further in the near future.

Currently, the average 10-year fixed mortgage rate with NHG is almost 1.2%, while the market interest rate is currently around 0.2%. When the market interest rate was also at this level in 2019, the average interest rate for the same mortgage was about 1.8%. This means that the gross margins for lenders are a lot lower now than they were then. If market interest rates remain at this level or rise further, banks will have to raise mortgage rates further.

Mortgage interest rates follow market interest rates

Higher mortgage rates

All of this, of course, has an impact on house prices. Since most people buy a house with a mortgage, the borrowing capacity strongly determines the maximum amount that buyers can pay for a home. If interest rates rise, households with the same income will be able to borrow less money. The high house prices can no longer be justified, there are no longer enough buyers to be found.

Due to fierce competition in the Dutch mortgage market, banks will try to wait as long as possible before implementing an interest rate hike. But the speed at which market interest rates are now rising means that a rise in interest rates is almost inevitable. Since the end of January, government bond rates in the Netherlands have risen by 40 basis points, while mortgage rates have risen by only 10 basis points over the same period. Moreover, it does not look like market interest rates will fall again anytime soon. After all, inflation is high and the ECB will first have to reduce its asset purchase programme, which will also put upward pressure on interest rates.

Dutch 10-year yields have risen sharply

What does this mean for the housing market?

Last year, house prices in the Netherlands rose by 20% due to the combination of a shortage of housing, falling interest rates and the influx of investors into the housing market. But if mortgage rates rise substantially again this year, it will certainly slow down the housing market. To give an example: In the United States, the 30-year fixed-rate mortgage rate is now at 3,85%. That is one percentage point more than in February last year. This means that a potential homebuyer who was able to borrow $400,000 last year will now only get a $350,000 mortgage on the same income.

A similar development in the Netherlands could significantly slow down the rise in house prices. This is a development that we should certainly keep an eye on, because Dutch households have a relatively large amount of mortgage debt. As long as house prices are rising, we feel rich and spend money easily. But if prices fall again and the residual debt problem returns, households will collectively hit the brakes again. The paper wealth can then evaporate just as quickly. In that sense, we have learned little from the 2008 crisis.

This contribution comes from Geotrendlines