How does inflation affect the housing market?
What You'll Learn: What you need to know about homebuying and mortgage rates during inflation.
EXPECTED READ TIME: 9 MINUTES
It’s one question that’s on everyone’s mind: Why is everything so expensive? The answer is endlessly debated and incredibly complicated. But it’s almost always chalked up to a single word: inflation.
As we’ll explain in this article, inflation raises the price of everything from eggs to energy — and housing is no exception. Whether you’re building brand-new construction, buying a well-loved Victorian, or even just renting, you can expect to pay more when inflation’s on the rise. We’ll take a look at how it all works and what it means for those looking to buy a home. But we’ll start with another very important question that’s on everyone’s mind: What is inflation?
What is inflation?
Inflation is the rate at which prices increase over a given period of time. In a normal, healthy, well-established economy, inflation is a natural phenomenon. Prices are almost always rising at least a little bit, and that’s okay. The problems start when that rate of increase speeds up — when prices rise faster than expected.
Economists keep tabs on the average price of goods, products, and services across a wide range of industries. And an increase in any one area doesn’t necessarily trigger an inflation red flag. For instance, if it’s unseasonably warm in September, your local pumpkin crop might not do so well, and you may notice higher than average pumpkin prices. That doesn’t mean we can blame it on inflation.
But let’s say that the cost of crude oil is suddenly spiking because of international policy disagreements. Then the cost of diesel fuel will rise, too. And so will the cost of shipping some new phone component. And the phone itself. And the services of a call center that depends on those new phones to do business. It’s easy to see how certain unexpected price increases can have a domino effect on other industries until there’s an economy-wide uptick in prices in general.
Do mortgage rates rise with inflation?
So we know that inflation can raise the price of, say, construction supplies and the new houses that require them. But what does any of that have to do with mortgage rates? While interest rates are not directly tied to inflation costs the way lumber or steel might be, they still may rise when inflation is high.
That’s because in the USA, as in most countries, interest rates are set by a central banking organization. It’s one of the many jobs of our Federal Reserve, aka “the Fed.” Now, when inflation starts heating up, the Fed is typically going to try to cool it off and make things more affordable for businesses and consumers. One of the main ways they do that is by raising the rate at which institutions can borrow money. These are the “rate hikes” you may have heard of.
It may sound counterintuitive to fight rising costs with rising costs, but the goal is to slow down demand on a larger level. Let’s say a consumer is really interested in a trip to Bermuda. They were set to pay for the whole thing with help from their favorite travel rewards credit card and stock up on points. But then the Fed announces a rate hike, and the credit card’s interest rate goes up, too. Suddenly, that trip seems less affordable, so our traveler holds off on booking it. The airline starts to notice that nobody is buying tickets, so they have to lower their prices to try and attract some business. Inflation goes down.
That’s the theory, anyway! Sometimes it can take a while to all work out, and rates will continue to rise even while consumer prices keep climbing. And unfortunately, that can make buying a home expensive on two fronts.
Should I buy a house when inflation is rising?
When inflation is on the upswing, buying a house can definitely be a challenge. But the economy is really just one factor in determining the right time to buy. A big factor, for sure, but not the only one.
While it’s true that a home is the largest investment that most people make, it’s also important to remember that it’s not just an investment. There’s always a deeply personal, deeply human meaning behind buying a home. And whether you’re setting out to start a new job in a new city, moving on from apartment life, or making a long-standing beach-home dream come true, there are huge, exciting reasons NOT to put a hold on your real estate purchase.
Besides, if housing costs are on the rise, there’s a chance that they can keep going up. And that means buying now could save you thousands of dollars when compared to a future price.
And let’s not forget that refinancing exists. When inflation slows down again (it always does!), there’s a good chance rates will go down as well. And then you can refinance and lower your monthly payment.
All told, determining the right time to buy a house depends on your unique desires, capabilities, and individual situation.
How to buy a house when inflation is rising
When inflation is rising and there’s no end in sight, you can be forgiven for asking yourself questions like, “When will the housing market collapse again?” But don’t despair. There are always strategies you can deploy to help buy a home even in the roughest of economic currents.
- Research market trends. We’re not kidding: A little bit of daily reading could save you thousands of dollars. When navigating stormy situations, every bit of insight can help make decisions. Maybe you’ll discover that a rate drop is in the forecast. Or a chief economist has written an article about how house prices will go down. Or the geo-political issue that caused the prices to rise in the first place has finally been resolved! The only way you’ll know is if you stay on top of the news. Being well-read and attuned to market conditions will put you in a better position than your less-informed competitors.
- Edit your budget. Okay, so your original budget is completely unworkable in this market. That’s alright. Maybe you can reconfigure things a bit. Shop around at a lower price point, or reel in unnecessary expenses, at least for a little while. It’s important to be honest and transparent with yourself about what can get trimmed, cut, or put on hold. And that brings us to our next point.
- Exercise flexibility. You may find yourself making more compromises than usual when economic factors feel constricting. But that could open you up to new possibilities you may not have considered before. Maybe you’ll start exploring a previously unknown neighborhood. Or maybe you’ll give a hard no a second look. It’s important to be open to new ideas and creative solutions — you never know what you might find.
- Build your finances. As crazy as it sounds, economic downturns can be the perfect time to build your credit and work toward a greater down payment. When costs are high, priorities tend to shift. Suddenly, a $200 night on the town could feel less worth it than a $12 movie at home and an extra boost in your savings account. Take some time and target your high-interest debt, or add some padding to your personal accounts. Your future self will thank you!
Pros and cons of homebuying during inflation
We know that buying a home is less than ideal when the housing market isn’t slowing down. But that doesn’t mean there isn’t a sunny side. Let’s take a look at some pros and cons.
Pros:
- Potentially less competition. Other homebuyers are facing the same headwinds and may choose to put their decision on hold.
- Advantages over renting. Landlords typically raise their fees with the rest of the world. And if you’re paying high living expenses, you might as well be building equity while you’re at it.
- It can always get worse. What’s considered expensive today can seem like a deal by tomorrow’s standards. If you can make it happen, make it happen.
Cons:
- Home prices. When the cost of building materials goes up, the cost of new homes goes up. But even older homes can be more expensive, as sellers take advantage of conditions to get as much as they can.
- Mortgage rates. Adding insult to injury, it can be more expensive to finance a house during times of increased inflation.
- More compromises. To find a home in your price range, you may have to accept some drawbacks and redefine your idea of what a dream home should be.
In summary, if you need a new house, you should buy a new house. Don’t let inflation spoil the party. But if you’re on the fence, or comfortable waiting things out until there’s an upturn, that’s a good option as well. Which brings us to our final question.
Should I wait for a recession to buy a house?
You know what they say: What goes up, must come down. So for a lot of people, that means putting their dreams of homeownership on hold until inflation slows and prices drop. But when will house prices go down? It’s hard to say. There are many factors at play — you could be waiting for a long time, and buying during a recession comes with an equally troublesome set of challenges.
But, if you stay vigilant and well-read, do your best to get your finances in shape, and keep expectations flexible, you’ll be well-suited to buy a home in any economic condition. Remember: The best time to buy a home is whenever you are ready to buy a home.