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Every real estate agent knows that the factors that affect the housing market are many and complex. However, the one factor that is influential beyond all others is interest rates.

Thats because interest rates determine how much it costs borrowers to borrow and lenders to lend. Not surprisingly, the higher interest rates are, the fewer people are going to be able to afford to borrow the money to buy real estate. When rates fall, that tends to draw into the market clients otherwise not interested. So when trying to determine the broad trends determining the direction of the real estate market, no single factor is likely to be more influential than interest rates.

But what determines what interest rates will be? In a totally unregulated free market, interest rates would rise or fall strictly based upon market conditions, rising when demand went up and falling when demand dropped. However, the housing market in the United States is anything but unregulated, as interest rates are set by a government agency known as the Federal Reserve, or The Fed.

The Fed does take into account supply and demand when setting interest rates, but it also considers a whole lot of other factors, some of them more political than economic. The Fed has a mandate to maximize the rate of employment, and since housing is one of the major engines of economic growth, the Fed has often pursued policies designed to maximize growth in the real estate sector.

Many observers of the real estate market blame government intervention in the housing market for the sluggish growth in housing in recent years. In a well-meaning attempt to boost both homeownership and the economy, The Fed kept interest rates artificially low. This resulted in many people buying houses they could not otherwise afford, and spurred the construction of new housing. However, this resulted in what economists call a bubble in the real estate market, where prices and the availability of housing rose above what the true values of homes as well as what the borrowers could repay. When the bubble burst in 2008, real estate prices tumbled and millions of homeowners were forced into foreclosure.

In the years since the burst, the real estate market has slowly recovered. In general, housing demand has risen, although pockets of sluggishness remain in some parts of the market. How extensive this recovery will be is heavily dependent on interest rates, which if they rise may cut off the recovery. Unfortunately, that is what many economists fear will happen, because the low interest rates The Fed imposed to encourage the recovery will be less sustainable as the economy continues to rebound.

People in the real estate market will have to watch The Fed very carefully in the coming months to see which way interest rates go. Whether the current recovery is sustainable long term will depend upon it.

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