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What Does Inflation Do To Mortgage Rates? A Guide For Uncertain Times

Dan Rafter9-minute read

November 22, 2022

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In Mid-April, the average mortgage interest rate on a 30-year, fixed-rate mortgage rose to 5%, according to Freddie Mac. This is the first time rates on this popular loan type have been that high in more than a decade.

At the same time, the annual inflation rate for the United States rose to 8.5% for the 12 months ending March of 2022, the highest since December of 1981, according to the U.S. Inflation Calculator.

Freddie Mac says that the combination of rising interest rates, high inflation, rising housing prices and a low supply of homes for sale has made buying a house the most expensive it's been in a generation.

And the big question? Will the United States’ current rate of inflation cause mortgage interest rates to rise even higher?

No one knows the answer to this question, but most economists say that the signs point to mortgage interest rates continuing to rise throughout 2022.

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How Are Inflation And Mortgage Interest Rates Related?

The interest rate on your mortgage loan depends on a host of factors. Some are within your control: Your rate tends to be lower if you have a strong FICO® credit score; you take out a shorter-term loan, such as a 15-year, fixed-rate loan; you come up with a larger down payment; and your monthly debts are low.

But some factors are outside your control, and those mostly have to do with the performance of the U.S. economy. Inflation is one of these factors. Typically, inflation leads to higher mortgage interest rates because it devalues the U.S. dollar.

"While inflation doesn't directly affect mortgage rates, it can indirectly cause mortgage rates to increase," says Amy Shunick, corporate financial controller at Bennett Packaging in Lee's Summit, Missouri. "Inflation is the devaluation of the dollar, which means that the purchasing power of your dollar decreases significantly as inflation increases. As inflation increases, so does the price of everything, including mortgage rates."

Inflation also reduces the demand that investors have for mortgage-backed bonds. As demand drops, the prices of mortgage-backed securities fall. That results in higher interest rates for all mortgage types.

In periods of higher inflation, mortgage interest rates tend to rise. This means that taking out a mortgage loan will become more expensive as higher interest rates lead to higher monthly home loan payments.

What Is Inflation?

The U.S. economy enters a period of inflation when the prices of goods and services continue to rise over time. If you go to the grocery store and chicken thighs are more expensive every week or head to the gas station and fuel prices are consistently higher every time you fill your car, you know the country is in a period of inflation.

When prices rise at a faster pace than do workers' wages, people feel an economic pinch. It now costs them more money that they don't necessarily have to fill up their cars, buy groceries, purchase electronics or order shoes or clothes online.

This could cause consumers to reduce their discretionary spending: If it costs consumers $150 to fill up their grocery carts this month when just 3 weeks earlier it cost them $130, they might spend less on other items.

"The impact of inflation is felt by everyone," says Dan Belcher, founder and CEO at Oklahoma City-based Mortgage Relief. "Homeowners can prepare for situations like this by paying off credit card debt and opting for a fixed-rate mortgage rather than an adjustable-rate mortgage."

Supply Side Inflation

During the earliest days of the COVID-19 pandemic, shutdowns and stay-at-home orders helped bring the production and shipping of goods across the world to a standstill. The increased demand that resulted for these products then boosted the price of them. This is an example of supply-side inflation, a type of inflation caused by a slowdown in the supply of goods and services.

Automakers, for instance, are still dealing with a low supply of the semiconductor chips needed for the higher-tech features of new cars. Home builders are still dealing with a shortage of construction materials. Both of these shortages are causing price increases, making new cars and new homes more expensive.

Demand Side Inflation

Another type of inflation is demand-side inflation. This happens when an increase in demand for goods and services causes prices to rise for them.

Again, COVID-19 played a role in causing the United States to get hit with this kind of inflation. To help people through the pandemic, the federal government passed out stimulus checks to many taxpayers. At the same time, people had more disposable income because thanks to stay-at-home orders and business closures, they weren’t spending as much money on entertainment.

This fueled demand for online shopping, as consumers ordered entertainment centers, new TVs, computers, smartphones, exercise equipment, outdoor toys and other items to entertain themselves. As demand for these items rose, so did shortages and prices.

Demand-side inflation also played a role in boosting the price of homes. Many people decided to move during the pandemic, whether from apartments to single-family homes or from smaller homes to larger ones. This boosted demand for homes and launched the U.S. into a prolonged seller’s market, in which buyers engaged in bidding wars to get their offer accepted. This caused the price of single-family homes to skyrocket throughout the pandemic. The National Association of REALTORS® reported that the median sales price for existing U.S. homes hit $357,300 in February 2022. That’s up 15% from one year earlier.

Other big-ticket items saw their prices rise as demand increased, too. Kelly Blue Book reported that the price that U.S. residents paid for an average new car rose by $6,220 in 2021. The company reported that Americans paid an average of $47,077 for new cars in December of 2021, the first time this figure ever rose past $47,000.

Inflation Spiral

Inflation is so worrisome because it can affect so much of the economy, with rising costs spreading from one sector of the economy to the next.

This, too, happened during the pandemic. Shortages in certain products, such as toilet paper and hand sanitizer, caused consumers to overbuy and stock up on these items. That further reduced the supply and causes the prices of these items to rise even higher.

Empty store shelves tend to cause consumers to panic. They might overbuy, say, chicken breasts at the grocery store because they worry that they won’t be there the next time they shop. This causes shortages and the price of these food items to continue to rise.

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How Do Inflation And Mortgage Rates Impact One Another?

The Federal Reserve is the central bank of the United States, and its mission is to keep both inflation and unemployment rates low through monetary policy.

Higher Interest Rates Set By The Fed

The Federal Reserve doesn’t set interest rates on mortgages directly, but it does control the federal funds rate. That’s the interest rate that banks charge each other for overnight loans to meet their reserve requirements. The interest rates on other loans, including those attached to mortgage loans, tend to follow the direction of the federal funds rate.

When the Fed raises its rate, then, mortgage lenders tend to raise theirs, too, something that has been happening in 2022. The Federal Reserve raised its federal funds rate by 0.25% at its March 2022 meeting. The agency said that it would continue to raise this rate in 0.25% – .5% increments until inflation falls.

Higher Mortgage Rates Demanded By Investors 

Once you close on your home loan, the odds are high that it will be bought from your lender by the government-sponsored enterprises of Fannie Mae or Freddie Mac. Fannie and Freddie then bundle, package and securitize the mortgages they buy, selling them to investors as mortgage-backed securities (MBS)

When interest rates rise in the U.S., bonds become more attractive to those investors who are worried about risk because bonds are backed by the full faith and credit of the United States. MBS investments, though, always come with some foreclosure risk. There’s no certainty that the borrowers behind these bundled mortgages will continue making their monthly mortgage payments. To compete against bonds in high-interest-rate environments, MBS investments must offer higher yields to investors. This drive for higher yields is another factor that increases mortgage interest rates. 

Another key factor? Early in the COVID-19 pandemic, the Federal Reserve bought agency MBS investments to keep demand for these products high and interest rates low. Starting in late January, though, the Fed has begun scaling back those purchases. During its March 2022 meeting, the Fed said that it would continue to sell the MBS products it had purchased early in the pandemic.

What Will Inflation Do To Mortgage Rates In 2022?

While no one can predict with certainty how mortgage rates will perform throughout 2022, it seems likely that they will continue to rise.

In addition to inflation, geopolitical events, such as Russia’s invasion of Ukraine, can also cause economic problems such as a rise in energy prices, which will also add a supply side shock to the economy and contribute to greater inflationary pressures. 

"Rising inflation not only shrinks people's purchasing power, but also affects the cost of borrowing," says Vicky Noufal, owner and associate broker with Platinum Group Real Estate in Leesburg, Virginia. "If the inflation rate rises, the interest rate will also follow the same trend. As a result, home buyers have to pay more for a mortgage. Anyone looking to get a new mortgage will have to pay higher monthly mortgage payments. So, inflation has a critical effect on the mortgage interest rate."

It’s important for home buyers to remember that even as they rise, mortgage interest rates still reached historic lows last year and in 2020. Even with increases, then, mortgages and car loans will still be relatively cheap compared to historical interest rates.

FAQs About Inflation And Mortgage Rates

Still have questions about mortgage interest rates and mortgages? Here are some answers:

Does inflation affect fixed-rate mortgages?

If you are already paying off an existing fixed-rate mortgage loan, higher inflation will not impact your payment. Your interest rate is already fixed and won’t rise even if interest rates rise for new mortgages. Those taking out new fixed-rate mortgages, though, will probably face higher interest rates.

What should I do if I have an adjustable-rate mortgage (ARM)?

An adjustable-rate mortgage, or ARM, is a mortgage loan with an interest rate that rises or falls over time. Typically, these loans start with an interest rate that is below market-value that remains in place for a set number of years, often 5 or 7. After this teaser rate ends, the rate on the ARM rises or falls, usually twice per year, according to the economic index the loan is tied to. In most cases, and especially when interest rates are rising, the rate on an ARM will increase during the adjustable period, causing the monthly mortgage payment to rise, too.

If you are worried about your ARM, consider refinancing into a fixed-rate mortgage while rates are still relatively low.

What happens to house prices during inflation?

During most periods of inflation, housing prices rise along with the cost of gas, groceries, electronics and other goods and services.

However, rising interest rates also tend to lead to fewer homeowners. Many are no longer interested in buying a home when interest rates are rising, others can no longer afford the higher monthly payments that come with higher rates. This slowdown in demand can lead to a cooling off of housing prices.

What will happen in 2022? That’s difficult to answer because the housing market has been so hot for so long, with home prices already rising faster than inflation. It’s difficult to predict, then, if inflation will cause prices to rise even higher or cool off the hot market.

What if interest rates go up while I’m shopping for a home?

Some lenders, including Rocket Mortgage®, offer a mortgage rate lock. You can typically lock in a set interest rate after getting preapproved for a home loan. This lock will remain in place, and your rate will not budge no matter what is happening in the economy, for a set period, usually 45 days. This can offer you financial protection in an environment of rising rates. Just be sure to move along on your house search quickly: If you don’t close you loan during the lock period, your rate lock might expire.

Typically, you can only lock your rate after you find a home. However, Rocket Mortgage allows you to lock your rate for up to 90 days while you search for a home with our RateShield® option.1 Even better, if rates fall, you can lower your rate once within that timeframe. You may see this referred to as a float down option.

The Bottom Line

While no one can predict the future of interest rates with any certainty, it appears clear that mortgage rates will increase in 2022 as inflation continues to batter the U.S. economy.

Are you ready to refinance your existing mortgage loan before interest rates rise too high? Want to buy a home and ready to lock in a mortgage before rates soar even more? You can begin your mortgage or refinance application online today to take advantage of today’s still-low interest rates. You can also give us a call at (833) 326-6018.

1 RateShield Approval is a Verified Approval with an interest rate lock for up to 90 days. If rates increase, your rate will stay the same for 90 days. If rates decrease, you will be able to lower your rate one time within 90 days. Please contact your Home Loan Expert for additional information. This offer is only valid on certain 30-year purchase loans. Additional conditions and exclusions may apply.

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Dan Rafter

Dan Rafter has been writing about personal finance for more than 15 years. He's written for publications ranging from the Chicago Tribune and Washington Post to Wise Bread, RocketMortgage.com and RocketHQ.com.