Inflation refers to an increase in the price of goods and services in an economy. When price levels increase, each dollar buys less. Consequently, inflation results in a reduction of the purchasing power of money. You’ve seen it at the grocery store. You’ve seen it at the gas station. What does it look like in the real estate market?
With inflation, banks also lose purchasing power on the money they earn back on mortgages they write. Therefore, interest rates must rise to keep investors interested in lending.
The net net: buyers may need to lower their budgets. In 2020 and 2021, interest rates were at all-time lows. The 30-year fixed-rate hovered around 2.75%. By the end of 2022, that rate is expected to rise to about 3.75. For a $1 million dollar home with a 20% down payment, the difference in monthly payment between those two interest rates is about $439 a month. When salaries and monthly income are not rising at the same rate, we have less discretionary money to spend each month.
At the same time, home prices have been rising. According to the National Association of Realtors, the median price for a home ended 2021 15.8% higher than the end of 2020. While prices are expected to rise at a slower pace in 2022, even the most conservative economists still expect home prices to rise by at least 5%.
There is a silver lining. Real estate has historically been viewed as a hedge against inflation. Home values traditionally at least keep up with inflation, and when you have a mortgage, you lock in a fixed monthly payment for the length of the loan (typically 30 years). Even at higher prices, with higher interest rates, the cost of homeownership will ultimately be lower than the cost of renting. Rent is more unpredictable than a mortgage and is more likely than not to go up. With the cost of building materials, appliances, light bulbs, paint, etc., increasing, these expenses, to some extent, will flow into the cost of maintaining rental homes. And it’s not the landlord who will be absorbing those costs.
If you tried unsuccessfully to buy in 2021 and are re-thinking the idea in 2022, take heart. Realtor.com is predicting an easier time to buy as early as this spring. A fall survey of 1,300 American homeowners found that 26% plan to sell their homes in the next 12 months. That's more than twice the findings from their previous year’s survey. This means less competition and slightly more options for buyers. And when you consider that just 10 years ago, the average interest rate on a 30-year loan according to Freddie Mac was 4.45%, a rate of 3.75% is still quite low.
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