The Relationship Between Inflation & Mortgage Rates

Inflation directly impacts interest rates that are set by the central banks. When inflation is high, rates are raised to try to maintain economic stability. Mortgage rates move in tandem with inflation. Higher  inflation results in increased mortgage rates, making borrowing for prospective homebuyers more costly. MLOs should understand how inflation affects the mortgage market and be prepared to navigate their clients through often unpredictable changes.  

The Economic Dance of Inflation & Mortgage Rates 

The way that inflation and mortgage rates relate to each other is a complex interplay that relies on other economic factors, such as the direction of the market, central bank policies, and the perceptions of speculators and investors. There are two primary relationships that demonstrate how the relationship between inflation and mortgage rates flows: Direct and Inverse.  

1. Direct. When inflation is high, interest rates are usually raised by the respective country’s central bank. In the United States, that’s the Federal Reserve. The interest rate increase serves to curb across-the-board price increases. 
2. Inverse. Mortgage rates are related to yields on government bonds. An increase in interest rates will cause bond yields to increase. When interest rates fall, bond yields fall and so do mortgage rates. 

Other Factors Influencing Mortgage Rates 

Several factors affect mortgage rates, causing them to fluctuate as the individual factors change. 

1. Inflation. Inflation causes pressure on the economy and diminishes the value of currency over time. Lenders adjust interest rates in response to this loss of value. So, mortgage rates may increase.  
2. Home Pricing Trends. High demand for homes can result in rising prices. Increased housing costs will usually lead to higher mortgage rates. 
3. Global Markets. Economic changes hardly happen in a vacuum. Global economic instability may lead to increased financial behaviors, such as safe-haven assets, and affect interest rates.  
4. Lender Operations. The cost of doing business could compel lenders to modify their rates. Between general operating costs and managing risks, the cost of their loan products may increase.  

Real-World Implications: How Inflation & Mortgage Rates Affect Our Work 

Inflation can affect the work that mortgage loan originators do because mortgage rates can influence the overall landscape of lending. As an MLO, you’ll need to stay informed about the status of the market to offer your clients the best service. Some of the key factors that may affect your day-to-day practice are: 

1. Communication. You may find that the types of communication you have with new clients, existing clients, and lenders will evolve. With clients, there may be an increase in the need to educate them on pending loan applications, choice of loan programs, or refinancing opportunities. With lenders, MLOs will have to pay more attention to changing guidelines. 
2. Shift to Refinancing. As an MLO, you may find that more clients will contact you for help with refinancing when mortgage rates change.    
3. Change in Underwriting. Lenders may adjust their risk tolerance in the face of economic changes. In turn, MLOs will need to make sure they are up-to-date with new underwriting standards and be able to communicate those changes to their clients.  
4. Client Relationship Management. In a turbulent economy, clients may become more anxious about their lending options. An MLO should be proactive in their interactions with new and existing clients.  

Inflation & Mortgage Rates in Action 

Let’s take a look at two cases that demonstrate the interplay of mortgage rates and inflation in action.  

Case Study: A High Inflation Scenario & Its Impact on Mortgage Rates 

In 2019, a study performed by Wroclaw University in Poland sought to demonstrate how inflation affected adjusted adjustable-rate mortgages and personal finance. Using a string of simulations, the researchers adjusted real and nominal costs of mortgages. They found that the real costs of mortgages decreased as inflation increased. When inflation decreased, the costs of mortgages increased. Keep in mind that adjustable-rate mortgages operate differently than fixed-rate mortgages and are designed to move according to greater economic factors.   

Looking at the period between 2015-2017, most of the world’s economies were experiencing low inflation. The Federal Reserve Bank had its policies set to stimulate growth, so inflation was held at bay. Mortgage rates were low, as the banks wanted to spur consumer borrowing. Lower mortgage rates led to increased demand for homes and buyers had choice financing options and terms. Additionally, consumers seeking to refinance also found favorable conditions to do so.  

This demonstrates the complexity of macroeconomics and how even small shifts in economic policy can have much larger impact.

Explaining Inflation as a Mortgage Loan Originator 

Clients trust their MLOs to guide them every step of the way, which includes explaining complex financial principles. MLOs should be ready to explain the impact of inflation on the mortgage journey. Discussing the ebbs and flows of the economy may be intimidating, so here are some ways to make it more comprehensible. 

1. Simplify Inflation. Most people have a remote understanding of inflation, but don’t necessarily understand how it relates to purchasing power. Using simple language and real-world examples can be more helpful. 
2. Connect the Dots. Once your clients understand inflation, you can explain how the economy reacts to inflation. Interest rate hikes are put in place to fight inflation, but the result is that mortgage rates also increase.  
3. Add Context. Show your clients how inflation will affect their homebuying journey, including the cost of borrowing, total home affordability, and the potential for future leveraging.  
4. Address Questions. Your clients will likely have questions, and it’s up to you to answer them to the best of your ability. 

Of course, the first step to being a mortgage professional is a good mortgage education. The more knowledgeable you are about the mortgage industry and process, the better you can service your clients.