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

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.

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.

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 t