How does inflation affect mortgage rates?
Quick insights
- Inflation can influence mortgage rates. When inflation or inflation expectations rise, investors often demand higher yields, which may contribute to higher mortgage rates.
- Inflation trends may also cause the Federal Reserve to raise the federal funds rate, which can contribute to higher mortgage rates.
- Higher mortgage interest rates make borrowing more expensive, increasing monthly payments and the total interest paid over the life of the loan.
It’s no secret that the housing market moves with the larger economy. Inflation affects interest rates, which in turn influence mortgage costs. If you’re a homeowner or shopping for a home loan, understanding the relationship can help you navigate a shifting market.
Mortgage interest rates generally don’t move randomly; they respond to economic forces over time. Rate changes often reflect broader trends in inflation, Federal Reserve policy and overall market conditions. You can explore more about how mortgage rates change over time in our guide on rate fluctuations.
But how does inflation affect mortgage rates, and what does that mean for borrowers today? Let’s take a closer look.
What is inflation?
Inflation is the rate at which the general prices of goods and services rise over time. People usually notice inflation when prices increase faster than usual over a period of time. Inflation is often measured by the Consumer Price Index (CPI), which reflects changes in the cost of living.
Inflation is caused by various factors including increased demand for products, higher production costs and government policy changes. When demand outpaces supply, prices rise, leading to inflation. When demand slows down, prices may stabilize or fall, reducing inflation. Monetary policy interventions by central banks or governments can also influence these trends.
Types of inflation
- Demand-pull inflation: Occurs when demand for goods and services exceeds supply, pushing prices up. For example, if everyone wants new homes at the same time but there isn’t enough inventory, home prices will rise.
- Cost-push inflation: When costs for businesses to produce goods or provide services go up, businesses could pass those costs to consumers. For example, if oil prices increase, transportation and manufacturing costs rise, leading a business to raise its prices.
- Built-in inflation: Also called wage-price inflation, it occurs when businesses expect higher future prices, and workers demand higher wages. Businesses typically pass these higher costs to consumers in the form of price increases. For example, if employees negotiate higher salaries after anticipating rising living costs, companies may raise product prices to cover the higher payroll.
- Hyperinflation: Extremely rapid and typically uncontrolled price increases, often caused by excessive money supply or economic collapse. Prices can double or triple in days or months, making currency lose value.
- Stagflation: A challenging economic situation where prices rise while economic growth slows down and unemployment stays high. Unlike traditional inflation, costs increase even when the economy isn’t expanding. This makes it difficult for policymakers to stimulate growth without worsening inflation. An example is what occurred in the United States around the 1970s, when high energy and food prices coincided with slow economic growth and rising joblessness.
What happens during inflation?
When inflation rises, it can begin to erode the “purchasing power” of your money—meaning you’ll need more cash to buy the same goods or services as before. To counteract this, central banks may increase interest rates, making borrowing more expensive, to reduce demand and alleviate the upward pressure on prices.
Higher interest rates can impact various sectors of the economy. As borrowing becomes more expensive, people may hold off on big-ticket purchases such as homes and automobiles, in turn affecting the broader economy. Higher interest rates may also make businesses less inclined to borrow money for expansion. These factors, along with others, contribute to shaping the impact of inflation on numerous markets, including the housing market.
Ways inflation affects mortgages rates
Now that we have a better understanding of inflation and how it influences interest rates, let’s discuss how it affects mortgage rates and what it means for current and prospective homeowners.
Impact on new mortgages
When inflation rises, central banks generally raise benchmark interest rates to help slow the growth of prices. This makes borrowing more expensive and pushes mortgage rates higher. For new mortgages, this means monthly payments can increase, especially for fixed-rate loans where the rate is locked in at origination.
Adjustable rate and fixed-rate mortgages
Adjustable-rate mortgages (ARMs) are also impacted, though differently. While ARMs start with lower mortgage rates than fixed-rate mortgages, their interest can adjust over time based on market rates. During periods of rising inflation, the adjustable portion of an ARM may increase, potentially raising monthly mortgage payments for homeowners.
Historical mortgage rates
Historically, mortgage rates have closely tracked periods of high and low inflation. For example, in the late 1970s and early 1980s, U.S. inflation surged, and 30-year fixed mortgage rates hit double digits. In contrast, periods of low inflation (such as the 2010s) corresponded with historically low mortgage rates. This made homeownership more affordable, especially for first-time homebuyers. You can learn more about historical mortgage rates here. Overall, mortgage rates are influenced by both individual circumstances and broader market factors.
Refinancing during high inflation
If you already own your home, an increase in inflation might also make it more costly to refinance your mortgage. For those with fixed-rate mortgages, rising inflation and higher interest rates are less likely to impact your mortgage rates. Your rate doesn’t change, and monthly payments may remain the same. However, if you have an ARM that is beyond its initial rate period, refinancing to a fixed-rate mortgage may make it possible to lock in a stable interest rate and could protect against future rate increases.
In summary
Navigating the housing market can take some planning, especially when factoring in the relationship between inflation and interest rates. Inflation tends to influence banks’ decisions to adjust interest rates, potentially impacting costs for homeowners and homebuyers. By watching the broader economic landscape, inflation and interest rates, you can be equipped to make informed financial choices.
