How inflation can affect the Housing market

Inflation seems to be eating deep into the U.S economy and one may not be able to tell the extent of the current inflation, but it is clear that it is getting tough for a lot of people, and industries, of which the housing market is not left out.

In recent weeks, there has been a lot of discussion and conjecture in the news concerning the future of the monetary system in the United States.

An expert predicts strong inflation, while another predicts deflation, and yet another predicts stagflation. While no one can predict the future, it is prudent for informed real estate investors to understand how real estate inflation works.

What is inflation?

Inflation is defined as the average rise in the value of a set of products and services in a given country during a specific period, usually measured in years. Essentially, it's the depreciation of the dollar's purchasing power over time.

An increase in the general price level, which is frequently stated as a percentage, signifies that a unit of currency now buys less than it did previously.

Take, for instance, the average rate of inflation is at 1.8%. Whatever item you bought at the price of $400 the previous year, would most likely cost you an additional $7.20.

Looking at it from the surface, this might not seem like much, but when you tally up all of your purchases over the course of a year, including groceries, petrol, phone bills, massages, and so on, you'll end up with a considerably bigger amount and cost for items.

If a country's inflation rate is higher than average, it may have a greater impact. With a rate of 5%, the item which initially cost $400 would increase by about $20.

Inflation and the Housing Market

The effect on home prices is one of the most obvious relationships between inflation and the housing market. In general, rising home prices raise inflationary indices such as the Consumer Price Index (CPI).

More than simply inflation statistics can be influenced by rising house prices. It can also have an impact on people’s pockets by raising other costs.

An article published by the World Economic Forum revealed “When house prices rise, this increases homeowners’ wealth.  As homeowners feel wealthier, they pay less attention to the particular prices they pay for retail goods.  Retailers then respond by increasing their markups.”

The relationship that exists between inflation and the housing market does not just go in one direction. Another likely change could be that driving up the cost of construction materials, supply chain issues can cause inflation.

As a result, other prices, such as new home prices, may rise as greater construction expenses must be factored in. Also in existing homes, increased prices for upgrades such as kitchen equipment may be passed on to buyers.

Inflation in certain costs like building materials can hamper new home construction, making it more difficult for housing supply to meet demands.

For those who are already homeowners, inflation can work to their advantage seeing that as house prices increase, they can decide to take advantage of it by selling off a particular property.

Inflation and Housing Debt Payments

Existing homeowners paying housing debt payments, like home equity loans payments, may be affected by inflation.

With interest rates not even considered, the value of a property can fluctuate even if a homeowner's monthly payment remains the same in terms of the stated monetary amount.

A $2,500 mortgage payment in 2022, for example, might appear in writing to be much like a $2,500 mortgage payment in 2027. However, inflation may have led to an increase in that homeowner's salary throughout those five years.

Perhaps instead of earning $80,000 per year, they earn $90,000 as a result of the cost of living rising alone.

What you will then have would be them paying, a $2,500 mortgage payment on a salary of $90,000, instead of paying $2,500 on a salary of $80,000.

Looking at it this way, it would seem like the price got cheaper as a result of inflation

Inflation does not necessarily follow a straight line. Other expenses may have increased as well, making the mortgage more difficult to afford in the future, even if the cash amount remains unchanged.

Because inflation affects interest rates, prospective borrowers and variable-rate borrowers may find that their debt payments tend to surpass any wage increases.

Inflation’s Negative Impact on the Housing Market

Consumer prices are not the only thing that is affected by inflation. Housing costs fluctuate depending on several factors, including the cost of construction materials, the cost of living in a certain area, and the demand for housing in that area.

The sad news is that, as long as consumer price inflation continues to climb, the cost of housing will undoubtedly rise as well and may even outrun inflation.

To get a better understanding, here are some consequences of inflation on the housing market.

• Increase in the Cost of Building a House. Consider all of the materials required to construct a new home, from concrete and bricks to drywall and stucco.

As a result of inflation, all of these needed components have increased in price for homebuilders. Have in mind that inflation is a rise in the price of goods that are consumed daily.

• Home Prices will increase. Assess the implications of rising homebuilding expenses yet again, because they place a greater financial strain on homebuilders, they have no choice but to compensate by raising listing prices for newly constructed residences.

However, inflation isn't the only factor that causes housing prices to grow. House prices rise naturally when the central bank raises the supply of money which is a key source of inflation.

• Purchases of financed homes decline. In the case of debt, inflation has an effect on the housing market. When inflation grows, making money more expensive to borrow, people borrow less of it, if at all they even decide to borrow. As a result, fewer mortgage-financed property purchases occur, potentially dampening economic growth.

What happens to the Houston Market?

“Home prices are still rising”, according to the Houston Association of Realtors (HAR), “and the single-family rental market is still strong and robust.”

Although a strong real estate market like Houston might be difficult for homeowners, it can be perfect for investors looking to buy single-family rental properties.

Due to Houston's robust job market, more individuals are flocking to the city, and when the home market is constrained, they opt to rent instead.

You might ignore Houston because of the frenzy around Texas real estate cities like Dallas and San Antonio.

But Houston provides real estate investors with exceptional value and access to a significant housing market in the United States.

What happens to Houston buying and selling?

As housing prices in Houston continue to rise, more people are opting to rent rather than buy. Houston's median single-family house prices have risen 16.3% year over year.

As with other states and locations, the inflation might hinder buying and selling, but those who intend to own a home can afford to make some compromises in places such as Houston.

How does inflation affect mortgage interest?

To evaluate how to guide monetary policy, the Federal Reserve, the United States' central bank, examines inflation rates and trends using several key variables, including the Consumer Price Index.

Interest rates indicate the cost of borrowing money from someone else. Borrowers who take out loans and lines of credit pay interest as a fee for the opportunity of using the lender's funds.

Mortgage rates are not directly affected by inflation rates. However, due to the way inflation affects the economy as a whole, there may be unintended consequences.

Mortgage rates are affected by economic conditions. Mortgage rates tend to climb when the economy is robust and inflation is rising.

As the economy slows and inflation rates fall, mortgage rates tend to reduce. This has to do with how the Federal Reserve adjusts interest rates to either calm or jump-start the economy.

The Federal Reserve, on the other hand, does not set mortgage rates. Instead, fixed-rate mortgages are linked to 10-year Treasury rates, which are government bonds that mature in ten years.

The 30-year mortgage rate tends to rise in lockstep with the Treasury rate.

Short-term loans, such as adjustable-rate mortgages, are affected by the federal funds rate, which is set by the Fed and used by banks to lend money to one another.

The simple answer to what influences mortgage rates is a change in the 10-year Treasury yield. Higher yields can result in higher interest rates, whereas lower yields might result in lower interest rates.

At any given time, inflation, interest rates, and the economic environment can all combine to influence mortgage rates. 

Although they don't always move in unison, higher mortgage rates are frequently accompanied by rising inflation rates.

What rising rates mean for the housing market

In the United States, central banks began raising interest rates in 2022, affecting areas such as mortgage interest rates.

According to the U.S. National Association of Realtors (NAR), “Although the Federal Reserve doesn't set up mortgage rates, a higher rate for banks typically makes borrowing more expensive, affecting the 10-year Treasury bond – an indicator for mortgage rates.”

Whether taking out a fixed-rate or variable-rate mortgage, higher mortgage rates can have a direct impact on new homeowners.

If you take out a new loan at a time when interest rates are high, your monthly payments will be higher than they would be if you took on debt at a time when interest rates are low.

Rising interest rates can also affect current homeowners who have variable-rate mortgages or variable-rate home equity loans.

Housing loan charges could rise the next time a lender alters rates. And, given the current inflationary environment, interest rates are projected to climb in the near future, raising the cost of variable-rate mortgages.

It's not like variable-rate borrowers constantly lose money when interest rates climb. Costs may rise temporarily, but a variable-rate mortgage may still be less costly throughout the mortgage.

The reason why this is so is that variable-rate mortgages start at lower rates than fixed-rate mortgages. However, if interest rates increase through part of the loan term, they may fall later, allowing variable-rate borrowers to benefit from lower rates and they won’t have to refinance.

Decisions to make with inflation and rising interest rates in the housing market

Rising inflation and interest rates might be challenging for the housing market, but they don't always result in severe affordability issues. Furthermore, it can be difficult to forecast how events will unfold.

Inflation and interest rate changes might influence decisions like whether to buy or sell a property or draw from home equity, depending on the unique circumstances and preferences. These factors can also influence whether to choose variable or fixed-rate loans.