If home sales are dropping, why are prices still on the rise?

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Ordinarily, declining property sales will cool the costs for housing. But existing-home sales have been underperforming their potential for 40 straight months and property values are still on the rise, according to First American Financial Corp.

This not-so-typical scenario can be attributed to one key cause: rising mortgage rates.

"Why are home sales declining, but house prices rising? This may be counterintuitive to some, but declining home sales and rising house prices is not a surprising phenomenon because mortgage rates have been rising," said First American Chief Economist Mark Fleming. "The Fed has been raising rates for almost two years after a long stretch where monetary policy was geared to keep rates near historic lows."

"Higher mortgage rates reduce affordability for the first-time homebuyer, constricting demand. But, higher mortgage rates also create a financial disincentive for existing homeowners with low rates on their existing mortgages from selling their homes, thus limiting supply. Existing-home sellers are also homebuyers, so the financial disincentive from higher mortgage rates impacts both sides of the supply and demand dynamic," he added.

Though mortgage rates continue rising, a stronger economy and increased demand from millennials, who comprise the largest cohort of homebuyers, will help support the housing market.

While the market still underperformed its potential by 7.4%, or 457,000 sales in November, the gap between existing-home sales and the market potential for sales did narrow 1.2% from October to November.

The market potential for existing-home sales grew 1.8% in November, marking an annual increase of 109,000 sales.

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Purchase Mortgage rates Home prices Housing market Housing inventory First time home buyers Interest rates First American Financial Corp.