In Part 1 of this series on Real Estate and Inflation, we discussed how monetary inflation creates price inflation which affects materials costs, creates a shift into rentals and a surge in foreclosures. But on the flip side, being a commodity itself, home ownership can provide protection against inflation and through the use of a mortgage allows you to pay off an appreciating asset with depreciating dollars.
This time we will look at a few more effects of Inflation on the average home buyer.
In a period of high inflation, a dollar’s value decreases rapidly. On average, a 2 percent inflation rate means that what costs $1 in 2017 would cost roughly $1.02 in 2018. Although inflation is not always spread evenly over all items, this means that a house that costs $100,000 in 2017 would cost roughly $102,000 in 2018.
Just like interest compounds on a savings or brokerage account, inflation increases the price of an item exponentially over time.
Inflation and Interest Rates Are Usually Correlated
As inflation increases the FED tends to raise interest rates, so as inflation heats up not only do house prices themselves go up but so does the interest rates on your potential mortgage. Thus making it twice as hard to afford to buy a house. In a high inflation environment you are best off locking in your interest rate with a Fixed Rate Loan if possible. Because if interest rates are rising and you have an adjustable rate mortgage (ARM), when the adjustment kicks in, your monthly payment will go up. Even though you are still paying the same amount toward principal you are paying more for interest. However, Fixed Rate Loans have higher initial interest rates i.e. the bank offers a discount to encourage you to take an adjustable mortgage, since they have a lower risk over the life of the mortgage. But in a rapidly rising interest environment you don’t want the risk of being priced out of your house.
During times of high inflation, more people are forced to obtain an FHA loan. FHA loans allow lower down payments and credit scores than traditional loans because they are insured by the Federal Housing Administration (FHA). Typically, they allow down payments of only 3.5% for credit scores of 580+. And 10% down payments for borrowers with a credit score of between 500 – 579. Unfortunately, the lower the credit score, the higher the interest rate you will have to pay.
Growth in Prices May Impact Inventory
As prices increase, more people see investing in real estate as a path to riches, so real estate investment courses pop up everywhere and people begin buying not only a house to live in, but one to rent out as well. This causes a shortage in the supply of houses, thus further driving up the price of available houses creating a “self-fulfilling prophesy” or “positive feedback loop”. At this point, the “common wisdom” becomes that “housing prices always go up”. This continues until the vast majority of buyers are priced out of the market, at which point the price collapses and a recession begins. Although, the beginning of the recession could also be the cause of the price collapse.
Buyers May Seek Properties Farther From Cities
When homes are appreciating at a rapid pace, some may choose to sell their homes to secure their gains but they have to have somewhere to live so they tend to move where they can obtain a bigger house for the money they received from the sale of their old house. Property values tend to be higher in cities (or closer to cities) as they are close to major employers and other attractions (plus there are supply and demand issues involved). To get an affordable home, buyers may be forced to look to suburbs or more rural areas on the outskirts of town.
If you are a homeowner, you want the value of that property to grow as much as possible. However, if you are looking to buy, inflation could price you out of your dream home or dream neighborhood. Fortunately, government home loans or other options can make it possible to afford a home even in inflationary times. You can check Today’s Lowest Home Rates at a variety of sites on the internet to be sure you are getting the best deal.
You might also like:
- Ways Inflation Affects the Real Estate Market (Part 1)
- What is the Real Definition of Inflation?
- What Causes Inflation?
- Mortgage Options: The VA Home Loan
- First-time Buyer Mortgages
- Mortgage Jargon
- What is a Remortgage?
- What is Buy to Let?
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