How Inflation Might Impact Interest Rates & Home Prices

So far in 2021, the estimated annual inflation rate for the United States is 4.2%. With the housing market hot and home values already at historic highs in much of the country, higher inflation may put the prospect of buying a home further out of reach for many Americans.

The steady increase in prices, paired with a decrease in our purchasing power, affects housing markets nationwide. This includes Bernal Heights and San Francisco real estate.

To learn more about how inflation rates affect interest rates, home prices, and your ability to buy a home, keep reading. We’ll cover everything that you need to know!

The Power of Owning a Home

Owning a home is beneficial during periods of economic inflation. As a homeowner, you’re locked into a price based on when you purchased it, subject either to a mortgage or nothing at all if you paid cash. As home values rise — and more often than not, they do — you are saving money and gaining equity because you are a homeowner.

This is why experts consider housing to be a dependable asset during periods of high inflation. As the price of goods and services rise, your home’s value is likely rising in kind.

Broadly speaking, the value of your home rises at least by the rate of inflation times the cost of the house. As time passes, your down payment and mortgage get smaller and smaller relative to the growing equity you hold in your home. This makes owning a home a financial benefit any time, but especially amid high inflation.

Bonus Power: A Fixed-Rate Mortgage

If you do have an existing mortgage on your home, you may be getting even more from inflation. A fixed-rate loan is particularly beneficial during high inflation.

With a fixed-rate mortgage, your monthly payments stay the same over the course of the loan. But in inflation-adjusted dollars, by the end of your loan period you are paying considerably less.

Consider the most common type of fixed-rate mortgage, the 30-year conventional. In the 30 years since 1991, cumulative inflation has reached about 96% in the US. So, a $2,000 monthly loan payment in 1991 would equal $3,921 today in inflation-adjusted dollars. By locking in at a fixed rate 30 years ago, you would be saving nearly 50%.

We should note that this doesn’t mean that you should always opt for a fixed-rate mortgage. There are various mortgage types for a reason, and depending on your situation an adjustable-rate loan might make more sense. It all depends on your goals, finances and timeline.

Supply and Demand

Supply and demand are the main forces that drive real estate prices up and down. Supply and demand are even more powerful than inflation.

Even if inflation is high, overabundant housing supply will bring home prices down, just like high buyer demand will drive home prices up. Right now, the inverse is true: tight supply of listings has caused home prices to surge, even before the higher inflation rate of 2021.

However, interest rates do depend on inflation. One of the main reasons the Federal Reserve adjusts interest rates is to match their target inflation rate. Since mortgage rates reflect interest rates, mortgage rates also rise as inflation rises.

Here’s the thing: If mortgage rates rise too much, people will stop taking out home loans. Thus, the demand for homes will decrease and home prices will fall with it. Rather than a direct line from inflation to home prices, these factors all intertwine in a complicated web of economic incentives.

Refinancing Your Mortgage

Many economic experts recommend refinancing your mortgage when current rates are at least 2% lower than your existing rate. Thanks to refinancing, you can redeem yourself with a lower rate even if you signed onto a mortgage when rates were high.

Thanks to options like refinancing, a high mortgage rate can usually be lowered down the line. But pay careful attention to rates and additional fees before you take the plunge to refinance. If your new, lower rate doesn’t save enough money, you could end up paying more in the end after all the fees are added up.

The Harm of Persistent Inflation

In a perfect economic world, inflation would correct itself. As explained earlier, inflation and interest and supply and demand are all connected. If inflation rises, interest rates would rise, then supply and demand would find equilibrium once again. Theoretically, it can be a self-correcting system.

But truthfully, inflation can work much differently.

If inflation persists for a long period of time, it can be a major setback to the entire economy. In particular, inflation harms those with fixed incomes such as the elderly and disabled.

Inflation can be harmful even on an international scale.

As we mentioned, inflation causes the purchasing power of currency to fall. If this keeps happening, the nation cannot perform internationally against other countries. The currency will have become devalued. With the US Dollar as the de facto global reserve currency, rampant inflation in the dollar would have global implications.

So, for everyone’s sake, inflation is carefully monitored by the Fed, with a goal of healthy inflation around 2% and no runaway inflation that lasts forever.

Predicting Inflation

One of the biggest problems with inflation is its unpredictable nature. Sure, some indicators of inflation are big and glaring, but there are countless smaller factors that may go unseen or unreported. Ultimately, even the best economists are not 100% accurate.

That said, these are the two largest drivers of inflation with a high degree of predictability:

  1. The government spends a lot of money within a short period of time
  2. The treasury introduces too much money into the economy

Because of these factors, economic experts look at government spending and private spending to track patterns of inflation.

Investing in Bernal Heights and San Francisco Real Estate

Inflation, interest rates, housing prices — these are powerful economic concepts that are still hard for some to understand, and even harder to predict.

That’s why our best advice is to make decisions based on your own goals, finances and timeline. No one perfectly times the housing market, except by accident. No one has a crystal ball to tell the future.

When it feels like the right time for you to buy or sell a home, get in touch with our team of experts to start the conversation and discuss your options. We’re always happy to help!