The impact of mortgage rates on the housing market

Abstract

We analyze the relationship between mortgage rates and housing activity in the US, focusing on house prices. Employing impulse response functions (IRFs) and forecast variance ratios (FVRs), we address potential endogeneity concerns by instrumenting mortgage rates with changes in long-term yields. Our findings reveal a significant impact of mortgage rate changes on house prices, with the maximal implied long-run semi-elasticity being close to 10. The FVRs provide set-identified variance decomposition for the instrumented shock, suggesting that mortgage rate shocks explain 2%–25% of house price dynamics. The results also highlight substantial uncertainty, likely stemming from potential nonlinearities and regional factors influencing house price formation, which we further investigate. Additionally, we show that changes in mortgage rates significantly affect various dimensions of housing activity, including houses sold, construction, and building permits.