How Does Inflation Affect Mortgage Rates?

What Is Inflation?

Inflation refers to the general increase in prices of goods and services over time, which leads to a decrease in purchasing power. In other words, when inflation rises, each dollar you have buys a little bit less.

The most commonly used measure of inflation is the consumer price index (CPI), which tracks the average change in prices paid by consumers for a basket of goods and services.

How Does Inflation Affect Mortgage Rates?

When inflation rises, mortgage rates tend to follow suit. Here are a few key ways inflation can influence mortgage rates.

Higher Interest Rates

The Federal Reserve often raises the federal funds rate to combat inflation, the idea being that higher rates can help curb consumer and business spending and help bring high inflation down.

While the Fed doesn't set mortgage rates directly, its actions influence them indirectly. More specifically, the Fed's monetary policy decisions play a major role in shaping investor expectations. In turn, those expectations directly influence the yield on the 10-year Treasury note.

Because the 10-year Treasury yield serves as a key benchmark for mortgage rates, changes in Fed policy often ripple into the housing market, pushing mortgage rates up or down accordingly.

Learn more: How Does the Fed Affect Mortgage Rates?

Reduced Purchasing Power

When inflation is high, it erodes the value of money. For lenders, this means that the money they get back in the future will be worth less than it is today. To compensate, they may increase mortgage rates to protect their profit margins.

Market Sentiment

When inflation is high, rising prices for everyday goods and services can erode consumer confidence and make potential buyers more hesitant to take on a large, long-term financial commitment like a mortgage loan.

If enough buyers pull back, housing demand drops, which can put downward pressure on home prices and, in some cases, mortgage rates. Additionally, individual lenders may lower rates to attract new borrowers and keep loan volume steady.

Learn more: Buyer's Market vs. Seller's Market: What's the Difference?

Does Inflation Affect Fixed-Rate Mortgages?

Once you lock in a fixed-rate mortgage, your interest rate won't change for the life of the loan, even if inflation continues to rise. However, inflation can affect fixed-rate loans in several indirect ways:

• Higher rates: When inflation is high, fixed mortgage rates are likely to be higher than they would be in a low-inflation environment.
• Reduced affordability: With inflation driving up prices, including interest rates, your monthly payments may be higher than if you had locked in your mortgage during a period of low inflation.
• Opportunity costs: On the flip side, if you already have a fixed-rate mortgage at a lower rate, you're protected from rising rates and your loan becomes more valuable compared to new mortgages.

Is Now a Good Time to Get a Mortgage?

Deciding whether to get a mortgage during a period of inflation depends on your personal circumstances and financial goals. Here are some things to consider:

• Interest rate outlook: If you believe mortgage rates will rise even further, locking in a rate now may help you save in the long run. On the other hand, if experts anticipate that mortgage rates will go down, locking yourself into a loan now could mean a costly refinance later.
• Budget flexibility: Make sure you can comfortably afford your mortgage payment, even if inflation drives up the costs of other essentials like groceries, gas and utilities. You'll especially want to make sure that you don't end up house poor, which can make it difficult to work toward other important financial goals.
• Loan type: Fixed-rate mortgages offer more stability in times of inflation. However, if you're not planning to stay in your home for very long or you want to take advantage of lower market rates in the future, an adjustable-rate mortgage could be a better fit.
• Long-term value: Real estate often appreciates over time, so if you're buying a home as a long-term investment, rising rates may be less of a concern than short-term affordability.

Learn more: Should I Buy a House?

Plan Ahead to Stay Ahead

Inflation is just one of many factors that affect mortgage rates, but it can have a big impact on your monthly payments and overall affordability. Before you commit to a loan, take time to understand how the current economic climate could influence your mortgage and your financial future.

To help you stay prepared, Experian offers free credit monitoring that allows you to track your FICO^® Score^Θ and Experian credit report. A better credit score may help you qualify for lower interest rates, even in a rising-rate environment.

Monitoring your credit now can help you make smarter choices when you're ready to buy a home, regardless of where inflation is headed.