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How Does Inflation Affect Mortgage Rates?

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Mortgage rates and inflation are two crucial pieces of our economy and have a significant impact on each other. As a reminder, inflation is the increase in the prices of goods and services, which reduces the purchasing power of money as a result. 

On September 21, 2022, the federal reserve increased interest rates for the fifth time this year.[1] With inflation at a 40-year high,[2] you might be wondering how inflation and interest rates are related.

Rising mortgage rates and inflation can make life more expensive, pushing homeownership out of reach for some.

Let’s talk about the relationship between inflation and mortgage rates – and what it could mean for home buyers.

What Is the Relationship Between Inflation and Mortgage Rates?

When mortgage rates are low and it doesn’t cost much to borrow money, inflation tends to increase. That’s because there’s a lot of demand from home buyers, who are willing to pay more for a house because their interest payments are lower. When inflation goes up, mortgage rates typically rise to help slow inflation driven by high demand.

The relationship between inflation and mortgage rates is in constant flux. The goal of central banks around the world is to hit the sweet spot between a healthy level of inflation and affordable mortgage rates. 

Economists note that some inflation (at or just under 2% annually) is a normal expectation and a healthy part of a growing economy.[3]

If inflation deviates too much from that 2% target, the Federal Reserve (the central bank of the United States) will usually adjust its target interest rates to suppress inflation by slowing economic growth. 

Inflation is undesirable because, if it’s too high, the dollar becomes less valuable. For an idea of how inflation can impact your daily life, just look at the cost of eggs. In 1982, you could buy a dozen eggs for roughly $0.80; fast forward 40 years, and eggs are selling for an average of nearly $3 a dozen.[4] This is a perfect example of inflation because it shows how the same dollar has significantly less purchasing power. 

So what do eggs have to do with mortgages? Mortgage rates are largely determined by what’s happening in the economy – like inflation and monetary policy – along with the creditworthiness of the borrower and the loan type they choose.

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The Federal Reserve interest rate and mortgage rates

The Federal Reserve (aka the Fed) doesn’t tell banks how much interest to charge borrowers for a mortgage. But the Fed’s own target interest rate, known as the Federal Funds Effective Rate, indirectly influences the interest rate on mortgages and other loans – like auto loans and credit cards. 

The Federal Funds rate is how much it costs banks to borrow money from each other. If the Fed wants to help give the economy a boost, it lowers its target interest rate to make borrowing money cheaper for everyone, which encourages more debt and spending. 

If inflation is becoming a problem, the Fed will make it more expensive to borrow money, thereby discouraging some people from spending and taking on additional debt.

Increases and decreases in the Federal Reserve interest rate push mortgage rates higher and lower since they determine how much banks have to pay to borrow money. If the banks are paying more to borrow money, you can bet they’ll charge consumers more to borrow, too – hence, we get higher interest rates.

Real estate investing and mortgage rates

After a mortgage lender issues a loan, it’s common for it to get sold to investors in the form of an investment product known as mortgage-backed securities (MBS). 

In simple terms, an MBS is an investment consisting of a collection of mortgages. Investors can buy MBSs like they do bonds. As long as the borrowers in that pool of mortgages make their payments, the value of that MBS increases, and investors make money. 

If borrowers fail to make their payments, the MBS loses value, which was one of the causes of the 2008 financial crisis.[5] During the financial crisis, since subprime mortgages comprised these MBSs, they quickly became worthless, leaving large institutional investors holding the empty bag. 

Mortgage-backed securities play an important role in setting mortgage interest rates. If borrowers are defaulting on their mortgages, MBS prices decline. To entice investors to take on this increased risk, MBS will have to yield higher potential returns. So lenders will often increase mortgage rates when MBS prices drop. Conversely, when MBS prices rise, mortgage rates usually go down. 

How Treasury bonds affect mortgage rates

While the Federal Funds rate can move mortgage rates up or down, U.S. Treasury bonds – like the 10-year Treasury note – also influence mortgage rates. 

Treasury yields refer to interest the government pays investors who loan money by buying Treasury bonds. When Treasury yields increase and the government offers a safe path to investment returns, investors in mortgages expect even greater returns – since mortgage-backed securities tend to be riskier than government bonds. Therefore, lenders have to increase mortgage rates.

How Is Inflation Affecting Home Buying in 2022?

In 2022, inflation has sent the housing market to record highs, with the median price of a home in America crossing $400,000. Home prices climbed more than 14% since last year, with certain markets seeing appreciation rates of more than 30%.[7]

When inflation is running hot, the Federal Reserve makes it more expensive to borrow money by raising interest rates. Home buying then becomes a costlier proposition for those taking out a mortgage.

For some, the increase in mortgage rates can price them out of buying a home completely. First-time home buyers, for instance, will have to contend with higher home prices caused by inflation. But unlike buyers who are current homeowners, they won’t have a home to sell. Repeat home buyers, on the other hand, are facing the same high prices. However, they have the benefit of selling their homes and putting the proceeds toward a new home purchase.

Inflation sends home prices up but signals an end to a seller’s market

In general, inflation sends home values (along with the prices of everything from gas and groceries to clothes and cars) up. However, the increase in interest rates that usually follows a period of sustained inflation will often cause a shift away from a seller’s market and toward a buyer’s market

Why? Because when rates go up, demand from buyers decreases. And when there’s less demand from buyers, sellers may need to work harder to get offers, and home appreciation starts to slow down. 

How Can You Navigate High Inflation as a Home Buyer?

As a home buyer, high inflation can make it even more challenging to find an affordable home.

When inflation is high, it’s important for you to figure out how to get the lowest mortgage rate.

To make sure you get the best possible interest rate on your mortgage, you should:

  • Improve your credit score 
  • Compare mortgage lenders
  • Choose a fixed-rate mortgage over an adjustable-rate mortgage (ARM)
  • Maintain a low debt-to-income (DTI) ratio
  • Avoid taking out other debt (such as an auto loan or new credit card)
  • If possible, increase the size of your down payment

If you’re thinking about delaying a home purchase because of inflation, remember that inflation can also send rent prices up. Though mortgage rate increases can slow home appreciation, home values generally won’t drop just because mortgage rates rise. So you should still consider buying even when inflation is high, especially if mortgage rates haven’t caught up to inflation yet. 

Here are some additional tips for successfully navigating high inflation as a home buyer:

  • Adjust your expectations: No home is perfect. While you might want it all, sometimes you have to compromise a little.
  • Broaden your search: If you’re looking in a ½ mile radius, try expanding your search to 1 mile. If you’re only looking at detached homes, consider exploring other options, like townhomes. 
  • Factor in higher expenses for repairs, maintenance and insurance: Inflation makes everything more expensive. So make sure you’re budgeting with these added costs in mind.
  • Think long term: If you’re taking out a 30-year mortgage, there’s no need to worry about what’s going to happen in the next year or two. Keep things in perspective and remember you’re in it for the long run.
  • Only buy what you can afford: Above all else, you should focus on buying only what you can afford. 

Inflation and Mortgage Rates FAQs

What are inflation rates today?

Inflation rates are constantly changing. In July 2022, inflation rates in the U.S. were at 8.5%.[8] If you want to find today’s inflation rates, check the latest consumer price index (CPI) on the U.S. Bureau of Labor Statistics website.

Do mortgage rates go up with inflation?

Typically, yes. When inflation gets too high, it’s the Federal Reserve’s job to prevent it from continuing to rise too quickly. So when inflation is up, the Federal Reserve exercises its power by increasing interest rates to try and get people to spend less money, thereby lowering inflation.

Does inflation affect fixed-rate mortgages?

If you have an existing fixed-rate mortgage, inflation will not affect your current mortgage. Unless you refinance or recast your mortgage, you’ll pay the same amount every month. But if you’re looking to take out a different mortgage, inflation can impact fixed-rate mortgages on new home loans.

Does inflation affect adjustable-rate mortgages?

Inflation can affect adjustable-rate mortgages if mortgage rates increase. When inflation is high, it usually doesn’t take long before mortgage rates start rising. If you have an adjustable-rate mortgage, such as a 5/1 ARM, there’s a good chance your mortgage payment will go up at your next adjustment period if inflation is high.

Stay Informed But Don’t Spiral

Inflation and mortgage rates are closely related. If inflation rises, mortgage rates normally follow suit. While you should be aware of inflation and perhaps watch your spending when prices rise, there’s no need to panic. Just try to get the lowest mortgage rate possible, and most importantly, only buy what you can afford.

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The Short Version

  • As a home buyer, high inflation can make it even more challenging to find an affordable home
  • When inflation is running hot, the Federal Reserve makes it more expensive to borrow money by raising interest rates
  • If you have an existing fixed-rate mortgage, inflation will not affect your interest rate
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  1. Board of Governors of the Federal Reserve System. “Open Market Operations.” Retrieved September 2022 from https://www.federalreserve.gov/monetarypolicy/openmarket.htm

  2. U.S. Bureau of Labor Statistics. “Consumer Price Index – August 2022.” Retrieved September 2022 from https://www.bls.gov/news.release/pdf/cpi.pdf

  3. Federal Reserve Bank of St. Louis. “The Fed’s Inflation Target: Why 2 Percent?” Retrieved September 2022 from https://www.stlouisfed.org/open-vault/2019/january/fed-inflation-target-2-percent

  4. Federal Reserve Bank of St. Louis. “Average Price: Eggs, Grade A, Large (Cost Per Dozen) in U.S. City Average.” Retrieved September 2022 from https://fred.stlouisfed.org/series/APU0000708111

  5. Becker Friedman Institute. “Mortgage-Backed Securities and the Financial Crisis of 2008: A Post Mortem.” Retrieved September 2022 from https://bfi.uchicago.edu/insight/research-summary/mortgage-backed-securities-and-the-financial-crisis-of-2008-a-post-mortem/

  6. Mortgage Bankers Association. “Mortgage Applications Decrease in Latest Weekly Survey.” Retrieved September 2022 from https://www.mba.org/news-and-research/newsroom/news/2022/06/08/mortgage-applications-decrease-in-latest-mba-weekly-survey

  7. National Association of Realtors. “Single-Family Home Prices Display Double-Digit Increases in 80% of 185 Metro Areas in 2022 Q2.” Retrieved September 2022 from https://www.nar.realtor/blogs/economists-outlook/single-family-home-prices-display-double-digit-increase-in-80-of-185-metro-areas-in-2022-q2#

  8. U.S. Bureau of Labor Statistics. “12-month percentage change, Consumer Price Index, selected categories.” Retrieved September 2022 from https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm

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