Question

If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?

Short answer

Despite rising mortgage rates, the true cost of financing a home is thus lower.

Step-by-step solution

Step 1. Introduction

An interest rate indicates how much it costs to borrow money or how much it pays to save money. So, if you're a borrower, the interest rate is the cost of borrowing money expressed as a percentage of the entire loan amount.

Step 2. Explanation

Compute real rate of interest:

$$\begin{gathered} r=i-\mathrm{\pi } \\ \left(\mathrm{Before}\right)\mathrm{r}=5\%-2\% \\ =3\% \\ \left(\mathrm{After}\right)\mathrm{r}=10\%-9\% \\ =1\% \end{gathered}$$

People are more likely to purchase homes now that the real interest rate they must pay has dropped from 3% to 1%. People are repaying more in dollars, but their property prices have increased at such a rate that the true cost of financing their homes has decreased.