How Inflation Could Eventually Lead to Lower Mortgage Rates

Inflation has been dominating headlines for much of 2022. Federal Reserve policy decision making and rate hikes have contributed to some of the most quickly appreciating mortgage rates we have seen in years. There is a reason for it, whether we like it or not. However, this week’s question is: How can inflation eventually lead to lower mortgage rates?

San Diego homeowners have experienced some of the greatest home price appreciation they have ever had over the past 18 months. At the same time Fed policy created the lowest mortgage rates ever. These 2 functions created the highest mortgage volume total in history in the year 2021. That represents quite a bit of buying and refinancing. Matched with stimulus payments, PPP loans to businesses, and a whole bunch of inventory and supply chain issues, our overall economy quickly became under tremendous inflationary pressure that we now must face head on. Both Producer Price Index (PPI) and Consumer Price Index (CPI) have risen at speeds we haven’t seen in over 40 years. Until we see that flatten out, upwards is the current momentum we are dealing with.

The only way to combat this rapidly rising inflationary pressure is to increase the borrowing costs in the marketplace, which in theory slow down spending and borrowing across the board. The desired outcome is for prices to stabilize, or flatten, and bring us to a soft landing economically. Now, with this in mind, let’s peek into the banking system and see what threats higher and sustained interest rates create in the housing industry.

We need to begin with increased mortgage interest rates. It’s pretty simple math, when mortgage rates increase, monthly and lifetime costs also increase. If rates are left at elevated levels for too long, this can bring the home selling/buying market to a grind. As fewer buyers are able to qualify for loans at elevated mortgage rates, the landscape of lending and real estate begins to take new form. We have already begun to see homeowners think twice about refinancing, and aspiring buyers get re-qualified at today’s higher rates in order to adjust to the local market here in San Diego. Further, within the lending industry there are layoff sweeping the country in all departments, from sales and marketing, to processing and underwriting. These are indications that they market is in for some headwinds this year.

Now, that brings us to the strategic angle of all this. What will the Fed allow to happen in the market, and for how long? It has become commonplace that the Federal Reserve bears the burden of keeping inflation in check and applying easing strategies or tightening strategies in times when necessary. The challenge then becomes the timing of it. Tightening too soon or too late can generate undesirable outcomes, and it’s not an exact science. As we are currently seeing, increased Fed Funds Rate has not yet begun to slow down inflationary pressures on the Producer Price Index (PPI) or the Consumer Price Index (CPI). Until we see those measurements begin to level off and turn downwards (i.e. inflation is coming down), the Federal Reserve is likely to keep up their rate increases. This comes at the cost of potentially stifling home sales, growth in first time home ownership, and even move up/lateral move buyers.

Which leads us to the silver-lining in this whole thing. Eventually the rate increase pressures the Fed is exercising right now will run their course and begin fighting back against inflation. It will take months, and maybe even quarters for this to all get balanced out. At that time, the Federal Reserve can come back to the drawing board and “normalize” their efforts to better control monetary policy which achieves the delicate balance between a healthy growing economy and affordability for everyday Americans hoping to buy or refinance their home. The evidence of this being on the horizon will be wholesale and consumer prices returning to in-inflated levels along with a healthier pace of home price appreciation in line with historical averages (vs. sky rocketing we have seen in 2020 and 2021). Until then we are on the lookout for a top to all things mortgage and real estate related. We are looking for a top in interest rates. We are looking for a top in home prices. We are looking for a top in inflation percentage across all categories in the economy. Once we get to the tops of the aforementioned, then we can start to expect a downward trajectory in all those same facets of the market.

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Rates & Fees Disclosure:
^‡ The payment on a $300,000 30-year fixed-rate VA loan at 3.000% with a 80% loan-to-value ratio is $1,292.01 with 0 (zero) origination points due at closing. The annual percentage rate (APR) is 3.235%. Payment does not include tax and insurance premium impounds. The actual payment amount will be greater. By refinancing your existing loan, the total finance charges may be higher over the life of the loan. Some state and county maximum loan amount restrictions may apply. Appraisal fee of $600, Processing Fee of $895, Underwriting Fee of $795 included in APR calculations with borrower paying 0 (zero) loan origination points.

^‡ Based on Mortgage Heroes internal data.