7 Questions & Answers About Inflation and Interest Rates

The housing market looks very different than it did in early 2022. Buyers and sellers are adjusting to the twin realities of high inflation and spiking mortgage interest rates, so your advice as an agent has to change in kind.

While it’s still a hot market for sellers, the tide is turning. Ballooning mortgage costs and rising home prices have begun to cool buyer demand for homes. The wildcard is fast-rising inflation.

Given the abrupt changes, many of our clients are likely debating whether buying or selling a home is a good move right now. To help you answer their questions, we turned to senior economist Jeff Tucker.

1. How high are mortgage rates likely to go, and how long will they stay there?

No one really knows.

“Many forecasters are surprised by how far they’ve already risen,’’ Tucker says. “One important fact to keep in mind is that, just because the Federal Reserve keeps raising the Federal Funds Rate this year and next year, that doesn’t mean mortgage rates must rise further in lockstep.”

Tucker says that lenders who are anticipating additional interest rate increases will likely have already priced those increases into the mortgage rates and fees they charge.

2. How do inflation and interest rates affect home prices?

In June, the annual rate of inflation hit 9.1% and ticked down just 0.6% in July. While it appears the Fed’s attempts to tame inflation with higher interest rates are beginning to work, they’re likely to remain on your mind for some time.

And if rates continue to rise, buyers still in the hunt for a home are likely to find less competition. That could make this a more favorable buying environment for less interest rate-sensitive shoppers, like retirees planning to buy with cash or only a small mortgage.

“Higher mortgage interest rates make homeownership more expensive, even if home prices remain the same,” Tucker says. “That dampens demand from buyers, causing them to look for lower-cost home options or stop house-hunting altogether.”

3. How can real estate continue to be a hedge against inflation and interest rates?

“Real estate can be considered a hedge against inflation because it offers people a way to lock in a major part of their monthly budget: the cost of shelter,” Tucker says. “Homeowners who have a fixed-rate mortgage can be assured of paying the same monthly mortgage bill in 20 years as they pay today.”

Taxes, insurance and homeowner association fees may change over time, of course. But the bulk of your monthly payment — the principal and interest on the original loan — remains the same with a fixed-interest loan until it’s paid off.

Meanwhile, rent is rising at its fastest pace since the 1980s, adding major budget uncertainty to renters considering their long-term housing costs. For some buyers, buying with a fixed-rate mortgage will shield them from much of this. It’s also insurance against potential rising interest rates in the future.

4. Do home prices drop when mortgage interest rates rise?

Not always.

It’s hard to say whether or how much prices will drop as interest rates climb. Recent research found that rising prices and interest rates have made mortgages less affordable than at any time since at least 2007. As a result, demand for homes is pulling back, price growth is easing, and sales are slowing.

Tucker says research from the Urban Institute found that, historically, high mortgage rates tend to be associated with periods of strong economic growth, low employment, strong wage growth and high inflation. These conditions usually mean that people have more money to spend, so they’re also associated with increases, not decreases, in home prices.

The one exception cited in the research: rapid increases in mortgage rates — like the ones we’ve experienced recently — are associated with slowing home value appreciation. This may disappoint would-be sellers who are postponing in the hopes of seeing home prices rise again.

5. Is an adjustable rate mortgage (ARM) is a better deal right now than a 30-year-fixed. 

That depends on the loan and what happens to interest rates in the longer term.

“ARMs, on average, provide a lower interest rate in the short term, but that rate is only available for a certain period,’’ Tucker says. “After the introductory fixed-rate period ends, there’s a possibility that the interest rate on the ARM will reset to a higher rate.” 

Tucker says buyers should look at the entire loan package when making comparisons. Give special attention to the differences in fees when comparing ARMs and fixed-rate options. 

If you’re thinking of taking out an ARM and planning to refinance later, you should consider how long you plan to live in the home and whether a higher rate in the adjustable phase would risk busting their monthly budget. If you have good reason to expect to be selling anyway—like finishing graduate school or a military family expecting a permanent change of station—then the interest rate adjustment risk may be a moot point.

6. How do inflation and the current housing market affect my clients?

If they’re selling and then buying their next home, they’ll almost certainly pay a higher interest rate if they’re financing the purchase with a mortgage. For some homeowners, the rate could be as much as 3 percentage points higher.

Advice to Sellers
Sellers called the shots for nearly two years. Now they’re facing challenges. Price growth has slowed as sellers begin to see the emerging picture of what buyers will actually be able to pay.

We work with sellers to price their home so that it reflects the realities of the market. Remind them that buyers have more budget pressure. If nearby sellers are cutting their prices, you want to be sure to price your home competitively to attract the best offers.

Today’s sellers and seller agents also have to prep their homes more thoroughly and bring their A-game to marketing, staging and photography. Sellers may not be seeing as many bidding wars, but ultimately they one need only one buyer to sell a home.

Advice to Buyers
Buyer budgets have taken a hit, but they no longer necessarily have to waive contingencies. Buyers can require an inspection and financing contingencies without as much fear that they’ll lose out to a competing bid. Similarly, buyers who can afford this market will generally have more time to consider. Encourage them to be picky and find a house they’ll love.

7. What other things should my clients consider?

“If your clients need to move for a job, or changing family needs, or just to start a new chapter, ask them if they can afford the home they’re looking at with today’s mortgage rates, and if they will love living there for several years,’’ Tucker says. “Those are the most important things to establish. In many ways, the movement of prices and interest rates in the years ahead will be irrelevant if they’re happy in their home.”