Americans are paying a lot more today for goods and services due to 40-year high inflation, a factor that impacts prices across the board, including for your mortgage and in real estate. Still, even with home prices up, getting in on the housing market now might help inflation-proof your future. Here’s how.
How a home purchase can hedge against inflation
Buying a home can be a hedge against inflation primarily because:
- As inflation rises, so should the value of your home.
- The loan-to-value (LTV) ratio of your mortgage will decrease as your home’s value increases over time. In other words, your fixed-rate mortgage payments stay unchanged while your home’s equity rises.
- If you buy a rental property, you can charge more for rent as inflation pushes prices up.
“Home price appreciation has been a nice hedge against inflation, with home prices growing slightly faster than the rate of inflation when measured over an extended period of time,” says Greg McBride, chief financial analyst for Bankrate. “The recent spike in inflation was preceded by a surge in home prices that insulated homeowners in a way that renters were not.”
The median sale price for a home rose from $329,000 in the first quarter of 2020 to $428,700 in the first quarter of 2022, according to the Commerce Department — an increase of about 30 percent in two years.
“Over the same period, U.S. inflation hit 11.5 percent,” says Al Lord, founder and CEO of Lexerd Capital Management, based in Summit, New Jersey. “This makes the average house price still [approximately] $68,000 higher than in early 2020, even after adjusting for inflation.”
If you get a fixed-rate mortgage, that could help safeguard against inflation, as well. That’s because you’ll continue to make the same monthly principal and interest payment while your home’s value climbs over time.
Likewise, if you invest in a rental property, you could see higher returns.
“While you own the property, if inflation rates continue to rise, so will the value of the home and your rental amount,” says Michael Gevurtz, president and CEO of Bluebird Companies, a real estate lender based in Philadelphia. “This means your profit margins will widen over time. As the prices for all goods and services increase, so can the amount you charge for rent, thereby increasing your return on investment.”
Relationship between inflation and the housing market
There’s a link between inflation and home prices that has become especially pronounced in the current economic environment, as both construction costs and demand have increased.
“Inflation causes materials required for housing construction to rise and serves as a decelerator of supply of new housing in the market,” says Lord. “When new construction slows down, the value of existing inventory tends to increase. Consequently, increased demand and moderating supply for housing lead to higher home prices, or housing inflation.”
Additionally, inflation makes it easier to secure financing to purchase a home, as more money is available to lend.
“Because more people can get loans, however, more people are chasing a set amount of houses, which then drives home prices up,” says Joel Ho, founder of InflationTraining.com, which provides education on inflation for companies and individuals.
How does inflation impact mortgage rates?
“The soaring mortgage rates of 2022 can be tied to inflation hitting four-decade highs and the Federal Reserve needing to aggressively raise interest rates in hopes of corralling inflation,” says McBride, adding that “while homeowners have had some insulation from inflation, homebuyers have not. Rising home prices and soaring mortgage rates have further undercut affordability for many would-be homebuyers.”
The Federal Reserve has already raised rates three times in 2022 and intends to do so again at the end of July. This has an indirect influence on fixed mortgage rates, as well as impacts the rates on adjustable mortgages and home equity products.
Where inflation is headed
No one owns a crystal ball, but for now, many foresee higher-than-normal inflation rates.
“It is not yet evident whether inflation has peaked or not,” says McBride. “What began on the supply side, first with pandemic-related supply chain issues and then a war in Ukraine, was also stoked by an environment of low interest rates and stimulative monetary policy. The price for reining in inflation may well be a recession, and it will take another year or two to get inflation back down to the Federal Reserve’s 2 percent goal.”
“There are signs that inflation will moderate at the level of 5 percent or 5.5 percent by the end of 2023, but this depends on the ability of the Federal Reserve to speed up increases in interest rates,” says Lord.
“Over the next quarter or two, we will likely see a temporary slowdown as Fed rate hikes hit,” says Ho. “However, because the federal budget constrains the amount of hiking the Fed can do, inflation will pick back up.”
Despite inflationary pain, now might still be a good time to buy a home provided you can afford the mortgage, have a stable source of income and don’t expect to move for the next several years. This’ll give the property enough time to appreciate, even with the potential for recessionary bumps in the near term.
“If you plan on owning the property for at least the next five to 10 years, the value of the property will likely increase,” says Gevurtz.