If the Housing Market Crashes, What Happens to Interest Rates?

If the housing market crashes, interest rates typically fall, but the extent and timing depend on several economic factors and policy responses. Here’s how it usually plays out:

1. Federal Reserve Response

In a housing crash, the broader economy often weakens, leading to lower consumer spending and potential job losses.
To stimulate economic growth, the Federal Reserve may cut interest rates to make borrowing cheaper and encourage investment and spending.

2. Mortgage Rates and Treasury Yields

Mortgage rates tend to follow the 10-year Treasury yield, which usually drops during economic downturns as investors flee to safer assets.
If demand for Treasuries increases, yields drop, and mortgage rates decline as a result.
However, if lenders see a higher risk of defaults (due to falling home prices and foreclosures), they might raise mortgage rates relative to Treasury yields to compensate for that risk.

3. Credit Availability & Lending Standards

Even if rates fall, banks and mortgage lenders might tighten lending standards due to higher default risks.
Borrowers with lower credit scores or smaller down payments could find it harder to get loans despite lower rates.

4. Inflation Considerations

If a housing crash triggers a broader recession, inflation might decrease, giving the Fed more room to keep rates low.
However, if inflation remains high (like in a stagflation scenario), the Fed may be forced to keep rates higher, even in a downturn.

5. Case Studies

2008 Financial Crisis: The Fed slashed rates from over 5% to near 0%, and mortgage rates fell significantly, but credit tightened dramatically.
2022-2023 Housing Slowdown: The Fed raised rates aggressively to combat inflation, leading to higher mortgage rates despite home price declines.

Bottom Line

If the housing market crashes, interest rates will likely drop, but mortgage rates might not fall as much if lenders tighten credit or if inflation remains a concern.