What Will Inflation Do to Mortgage Rates?

Getting the best rate on a mortgage matters because it can determine how affordable your monthly payments are and how much interest you’ll pay over the life of the loan. Low rates are a boon for buyers while rising rates can make homebuying more expensive. While not directly linked, consumer prices can influence movements in mortgage rates. If you’re poised to buy or refinance a home, it’s important to consider what will inflation do to mortgage rates.

If you need help figuring out how inflation will impact your homebuying experience, consider working with a financial advisor.

What Is Inflation?

Inflation is characterized by an extended period of rising consumer prices, as measured by the Consumer Price Index (CPI). The CPI catalogs prices for a variety of consumer goods and services, tracking changes in those prices over time.

When inflation is high, consumers pay more for basic necessities, such as gas or utility services. Prices for other goods and services can also go up. That means your purchasing power shrinks because your money doesn’t go as far. The negative impact on your wallet can be compounded when companies engage in “shrinkflation,” which means downsizing product packaging while charging the same or higher prices for those products.

The Federal Reserve aims for a target inflation rate of around 2% per year. As of March 2022, the U.S. inflation rate had reached 8.5%, the highest rate in approximately four decades.

How Are Mortgage Rates Set?

Mortgage rates are not influenced by any single thing; instead, there are several factors that can work together to push rates up or down. Those factors include:

Conditions in the bond market
Changes to the 10-year Treasury yield
Federal Reserve monetary policy management (specifically, changes to the federal funds rate)
Economic growth (or decline)
Inflation

Generally, mortgage rates tend to stay low during periods when the economy is doing well the Fed keeps the federal funds rate low. The federal funds rate is the rate at which banks lend money to one another overnight.

The Federal Reserve can adjust this rate to “steer” the economy through the different phases of the business cycle. When the economy is in danger of overheating, for example, the Fed may use rate hikes to cool it off. When the federal funds rate goes up, banks can raise rates on loans and credit cards. If it costs consumers more to borrow, they may decide to ease off borrowing and spending.

On the other side, a rate cut usually happens when the government wants to encourage borrowing and spending. If the economy is going through a recession, for example, the Fed can use rate cuts to make lending less expensive so that people will be inclined to spend. While mortgage rates operate independently of the Federal Reserve’s rate policy, they tend to move in the same direction.

Inflation can cause mortgage rates to rise, making homebuying more expensive for borrowers. Lenders may raise mortgage rates in an effort to minimize the effects of inflation on their bottom lines. The higher inflation climbs, the more mortgage rates could go up.

Even if lenders don’t impose higher rates on borrowers to protect profits, they may still raise rates to mirror changes to the federal funds rate. Again, the effect is the same: rising inflation can directly affect home affordability.

Here’s an example. Say you’re planning your homebuying budget and you want to spend no more than $1,500 per month on a mortgage payment. Assuming a 4% interest rate, you could theoretically afford to borrow $315,500 to buy a home.

Now, assume that inflation pushes mortgage rates up to 5%. If you’re sticking with the same $1,500 per month mortgage payment threshold, that shrinks the amount you can realistically afford to borrow to approximately $280,000.

That kind of price swing could drastically affect the types of properties you’re able to consider. You may be forced to rethink things like the area you want to live in, the number of bedrooms and bathrooms or the kinds of features you want, such as an upgraded kitchen or fenced-in yard.

How to Cope With Rising Mortgage Rates

Inflation can influence mortgage rates, causing them to climb alongside rising consumer prices. When mortgage rates are higher, you can do one of two things:

Put off your goal of buying a home until rates settle down
Look for ways to save on mortgage costs

Delaying homebuying may not be ideal but it could help you to save money if you’re able to get a lower interest rate. The caveat is that it’s not exactly easy to predict when inflation will begin to subside and mortgage rates will drop. If you’d rather not run the risk of having to wait months or even years to buy, then you might consider the second option instead.

Getting the best mortgage rate in a higher rate environment starts with working on your credit scores. The higher your scores, the lower your interest rate is likely to be. Some of the most impactful things you can do to improve your credit scores include:

Paying bills on time
Paying down debt balances
Limiting how often you apply for new credit
Keeping older credit accounts open
Using different types of credit

You could also get a lower mortgage rate by increasing your down payment or opting for a shorter mortgage term. A bigger down payment means less you have to finance and a potentially lower rate. That can also reduce your monthly payment.

Choosing a shorter mortgage term, say 15 years versus 30, could result in a lower rate as well. The trade-off is that you’ll have a larger monthly payment. You could, however, save more in interest over the life of the loan since you’re paying it off earlier.

Finally, you might consider buying points to buy down your rate. Whether this makes sense depends on how soon you expect mortgage rates to drop. It may be more cost-effective to wait for rates to dip, then refinance into a new mortgage with a lower interest rate.

The Bottom Line

Inflation is not a homebuyer’s best friend, as it can help to drive up mortgage rates. There are some things you can do, however, to get the best rate possible on a home. Paying attention to market conditions and accurately estimating your homebuying budget can help you decide on the right time to buy when inflation is rising.

Mortgage Planning Tips

Consider talking to a financial advisor about what inflation might do to mortgage rates if you’re preparing to buy a home or refinancing an existing home loan. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Keep in mind that mortgage rates can also affect what you pay to borrow against your home equity. Rates for home equity loans and home equity lines of credit (HELOCs) tend to already be higher than regular mortgage purchase rates already since these loans pose more risk for the lender. So if you’re considering tapping into your equity, consider what higher inflation might mean in terms of the interest rate and monthly payment. Also, take time to compare the best home equity loan rates online.