August 20, 2022

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Does Rising Inflation Impact Real Estate: 10 Things Home Buyers Should Know

Anyone who has looked at the stock market in the last month and a half is probably a little worried. Anyone who has heard experts talk about the stock market in the last month and a half is probably very worried. But the question is: Do you, as a homeowner, have to worry?

The Stock Market and the Economy

One thing worth mentioning as soon as possible is that the stock market is not the economy. It is easy to get to thinking that it is, and some people push this narrative quite hard for very self-serving reasons, but the health of the stock market is not a one-to-one indicator of the economy.

Interest Rates Have Recently Raised

It will certainly give you an idea of what is going on, however. For instance, at the beginning of April there was a big stink made in all corners of American business when the Federal Reserve announced that inflation was worse than they thought it was and decided to raise interest rates.

Interest Rates Discourage the Spending of Money

Interest rates mean two things: To begin with, they reflect how much money your savings make while sitting in your bank account. When your money sits in your bank account, it slowly grows over time. This is the bank rewarding you for letting them access your money as it sits there.

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Banks give out loans, and they also use their customers’ money to trade stocks. This is a risk, and the interest rate indicates the base reward the customer of a bank should receive for that risk. This also discourages you from putting the money into the stock market.

Interest Rates Represent Risk

The second thing that interest rates mean is the amount of money a person has to pay back in addition to paying back their loans. So, if you take out a loan of $100 at a 5% interest rate, you have to pay back $105. That extra $5 is for the service of the loan and the risk the loaner is taking by handing the money off to you. For a lot of reasons, not all loans get paid back.

Interest Rates Relate to Inflation

It is quite simple how interest rates relate to inflation: Imagine you are negotiating a loan. It is a $1,000,000 loan with a 10% interest rate. You expect to make $100,000 in profit off of this loan.

But while that $100,000 in profit sounds good now, there might be a time in the future when $100,000 is not as meaningful as it is now. For some businesses, that time has already come. There is a problem, however: The Federal Reserve has dictated that unless you can prove there is a risk to the investment, you cannot set the interest rate higher than 10%.

As a side note, the real number is not 10%. That is just an example provided at the Teifke Real Estate official website.

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Interest Rates Effect Everyone

In that example, the Federal Reserve only accepts a debtor having a 10% profit margin on their loans. This is meant to help discourage predatory loan practices. That number, 10%, reflects the base level of risk loans are presumed to be at, as well as the reward debtors can claim for it.

So, if the Federal Reserve raises the interest rate, they are saying a few things: They are saying that this 10% profit margin is insufficient. They are saying that the risk of giving out a loan is larger than 10% interest. They are saying that the values of all the money involved are too low.

Raised Interest Rates Account for and Cause Inflation

This leads to inflation because suddenly everything is more expensive. A business cannot open without a loan, and now they have to get more money to pay off that loan. That means higher prices across the board—after all, every business is subject to these increased interest rates.

How Does This Relate to Homeowners?

With all this talk about loans and the stock market, it is easy to forget: Your mortgage is a loan. It is a loan from a bank to help buy your house. That means if interest rates increase, the price of your house basically increases after you have already bought it. 

You can quickly picture the nightmare scenario: Inflation gets worse, interest rates raise, currency loses value, and the price of your home grows more and more while you are still paying it off. This is part of what led to the housing bubble of 2008.

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Housing is in a Bubble Now Too

While it is impossible to know all of the factors, it can be pretty easily identified that the housing market is in a bubble. What that means is that the prices for properties are wildly out of proportion from their actual value. A raise in interest rates is, in a way, meant to help this.

The idea is that raised interest rates will make it harder for banks to finance the buying of properties. The interesting thing is, this actually effects big businesses as much—and some might say more—than it effects average Joe home buyers. 

Supply of Property (and Everything) is Lowered

The primary target of these rising interest rates is inflation. In the short term, the interest rates will cause inflation by demanding more out of everyone. But in the long term, less loans will be given out because loans cost more and risk more. That decreases supply of many things.

It particularly lowers the supply of homes and property. And if supply is lower while demand stays the same, then cost has to lower in order to facilitate the conveyance of goods.

Conclusion

Rising inflation impacts real estate in a lot of ways. Right now, it means your home is getting more expensive. This is bad for paying it off, but somewhat good for people who have already paid off their homes. The danger comes when the bubble bursts, and a paid off home is suddenly worth less than its owners paid for it.