6 min read

How do inflation and rising rates affect the housing market?

Rising inflation and interest rates can affect the real estate market, but the cause and effect isn’t always so straightforward. See how these areas intertwine.

Jake Safane
April 14, 2022
Blog overview

What does inflation have to do with the housing market?

Inflation and housing prices

Inflation and housing debt payments

What do rising rates mean for the housing market?

Interest rates and real estate activity

Making real estate decisions amidst inflation and rising interest rates

Housing prices have been rising quickly across much of North America, and this trend looks set to continue in the near future. The Canadian Real Estate Association (CREA) projects average home prices will rise more than 14% in 2022. In the U.S., Zillow predicts annual home value growth reaching 17.3% by January 2023. 

At the same time, inflation and interest rates have also been on the rise. While there are ties between housing prices, inflation, and interest rates, these factors can get convoluted and don’t always move in the same direction.

Inflation can cause price hikes, such as for building materials, which pushes up the cost of new construction and renovations, thereby influencing the real estate market. But the relationship often works the other way around, where rising home prices increase overall inflation rates. For example, in the U.S, shelter accounts for about one-third of the calculation of the Consumer Price Index (CPI), which is a common measure of inflation.

Meanwhile, interest rate hikes can have the opposite effect. Amidst high inflation, central banks tend to raise interest rates to try to prevent the economy from overheating. These higher interest rates can make mortgages more expensive, thereby reducing demand from some buyers, which can then cause housing prices to come down or at least increase at a slower rate.  

Altogether, the longer-term picture doesn’t necessarily show a clean upward trajectory.

“Limited supply, higher prices and higher interest rates are expected to further tap the brakes on activity and price growth in 2023 compared to 2022, particularly in Canada’s most expensive markets,” notes the CREA in their quarterly forecast. Overall, in Canada, the CREA projects only a 3.2% increase in the national average home price in 2023.

Amidst all these changes, it can be useful to more closely examine inflation and interest rates whether you’re looking to buy a home, sell a home, or tap into your home equity (e.g., with a home equity loan or HELOC).

Even if it’s hard to predict exactly how these economic factors affect areas like home prices and supply/demand, learning about the relationship between inflation, interest rates, and the housing market might influence some of your decisions, like choosing between variable vs. fixed-rate mortgages. You still might have some uncertainty about the best way to take on housing debt and may want to consult with a relevant professional, but you can at least make more informed choices.

What does inflation have to do with the housing market?

Inflation can have a direct effect on the housing market, and the housing market can also influence overall inflation rates. That’s because inflation can take many shapes and affect multiple areas.

Inflation and housing prices

One of the clearest links between inflation and the housing market is the effect on housing prices. Generally, higher housing prices cause inflationary measures like the CPI to rise. As a White House blog post notes, “even small increases in rent and home prices can, in principle, have noticeable effects on overall inflation.”

Recently, higher housing prices have been driven by factors like strong buyer demand outpacing supply, as the pandemic has caused many people to reconsider where they live and work. Research from Zillow and the U.S. Census Bureau shows that right when many Millennials were entering their prime homebuying ages, they also experienced opportunities to buy houses in the suburbs and work remotely, rather than rent near city centers. 

As housing prices rise, that can affect more than just inflation stats. It can also affect wallets by pushing up other types of costs. 

“When house prices rise, this increases homeowners’ wealth.  As homeowners feel wealthier, they pay less attention to the particular prices they pay for retail goods.  Retailers then respond by increasing their markups,” notes an article by Stroebel and Vavra, published by the World Economic Forum.

But in some ways, the relationship between housing prices and inflation can work the other way around. For example, supply chain challenges can prompt inflation by pushing up the cost of construction materials. That can then inflate other prices, like for new homes, considering the higher building costs need to be accounted for. Even for existing homes, higher prices for, say, a seller replacing kitchen appliances might then get passed on to buyers.

Meanwhile, inflation in areas like building materials can stall the construction of new homes, which can then make it harder for the housing supply to keep up with demand.

Current homeowners, however, might benefit from higher inflation/higher housing prices. For example, maybe you were thinking of selling your current home and buying a new one in a less expensive area for retirement. Yet if inflation has pushed up home prices in your area, you might have more equity that you can tap into. 

By taking out a home equity loan or HELOC, you might be able to access more money for retirement than you realized, without having to move. Still, you’ll need to account for risks, like not being able to pay back your home equity loan or HELOC as other costs rise.

Inflation and housing debt payments

Inflation can also affect current homeowners making housing debt payments, such as home equity loans or HELOC payments. Temporarily, let’s put interest rates aside. Because even if a homeowner’s monthly payment remains the same in terms of the stated dollar amount, the value can change. 

For example, a $3,000 mortgage payment in 2022 might look the same on paper as a $3,000 mortgage payment in, say, 2027. But during those five years, perhaps inflation contributed to an increase in that homeowner’s salary. Maybe instead of earning $100,000 per year, they earn 10% more, i.e., $110,000, based solely on cost of living increases (putting aside merit raises for simplicity’s sake).

So, instead of paying $3,000 per month on mortgage debt based on a $100,000 salary, they’re paying based on a $110,000 salary. Relatively speaking, their mortgage got cheaper due to inflation. 

That said, inflation doesn’t always work out so neatly. Other costs might have gone up too, making the mortgage harder to afford in the future, even if the dollar amount stays the same. Some homeowners might be feeling that pinch now, such as with rising gas prices. And since inflation tends to push up interest rates, new borrowers and variable-rate borrowers might find that debt payments start to outpace any wage gains.

Some homeowners might decide to tap into their home equity as a way to ease high inflationary periods. Taking out a HELOC, for example, could provide more money for retirement expenses that may have gone up recently, like food and transportation costs. 

Again, there can be risks here, as you wouldn’t want to default on a home equity loan and lose your house. But if you’re willing to take the risk of tapping into some of your home equity and can afford interest payments, then you might be able to more easily navigate high inflationary periods or even recessions, when your other assets might not be performing as well.

What do rising rates mean for the housing market?

In addition to inflation, real estate participants can also be affected by interest rate changes. In 2022, central banks in Canada and the U.S. started to raise rates, which can influence areas like the cost of mortgages.

“Although the Federal Reserve doesn't set up mortgage rates, a higher rate for banks typically makes borrowing more expensive, affecting the 10-year Treasury bond – an indicator for mortgage rates,” explains the U.S. National Association of Realtors (NAR)

Higher mortgage rates can directly affect new homebuyers, whether they’re taking out fixed- or variable-rate mortgages. If you’re taking out a new loan during a period of high interest rates, then your monthly payments are generally more expensive than they would be if you took on debt during a period of low interest rates.

Meanwhile, current homeowners with variable-rate mortgages or variable home equity loans can also feel the effects of rising interest rates. The next time your lender adjusts your rates, your housing debt costs can go up. And in this current inflationary period, interest rates will likely rise in the near term, meaning the costs for variable-rate mortgages can also increase.

That said, it’s not as if variable-rate borrowers always come out on the losing end when rates rise. Temporarily, costs might increase, but over the life of the loan, a variable-rate mortgage might still be less expensive. That’s because variable-rate mortgages tend to start at lower rates than fixed-rate mortgages. And even if rates rise during part of the loan term, they could also decrease later on, enabling variable-rate borrowers to experience reduced interest rates, without having to refinance.

In fact, we ran an analysis at Fraction of average fixed vs. variable-rate mortgages in Canada. We found that from 2006-2016, on a forward-looking, five-year rolling basis, choosing a variable-rate mortgage rather than a fixed-rate mortgage would have been less expensive for borrowers in every period. Interest rates did end up being lower in 2016 than where they started in 2006, but there were both rate hikes and rate cuts during that stretch, as WOWA.ca shows.

To be transparent, Fraction offers variable-rate mortgages, but we welcome you to explore the data and consider what might work for your personal finances.

Interest rates and real estate activity

Rising rates can also have a direct impact on the state of the real estate market. For one, as higher interest rates can make mortgages more expensive, that can hurt home buying demand. You might not be as eager to shop for a new house if you know that you’d have to take out a new mortgage at a relatively high interest rate. 

NAR notes that amidst higher mortgage rates, over six million U.S. households have been priced out since just the start of 2022.

That said, interest rates don’t always have a predictable impact on the real estate market. While rate hikes from the Bank of Canada or Federal Reserve might influence mortgage rates, that doesn’t necessarily mean that housing prices, for example, will move in the same direction. 

“Everyone involved (myself included) believes interest rates have profound effects on housing and real estate markets. Second, nobody (myself included) has a clear and simple understanding of exactly what those effects are,” notes economist and professor Stephen Malpezzi in research published by the Rutgers Center for Real Estate.

For example, his research points out how a rise in mortgage rates during the 1980s corresponded to a drop in housing prices. But mortgage rates generally moved in a downward direction during both the boom and bust in the housing market in the 2000s.

Similar to inflation, rising interest rates often tell a complex story, so it’s not as if housing is always way more expensive on a relative basis during times rates go up.

“Rising mortgage rates impact affordability, but one of the root causes of rising mortgage rates is an improving economy, and an improving economy often leads to stronger wage growth. Rising household income can blunt the negative impact that higher rates have on house-buying power,” notes First American, a real estate financial services company.

Making real estate decisions amidst inflation and rising interest rates

As discussed, rising inflation and interest rates can pose some difficulties for the real estate market, but they don’t always create dire affordability concerns. Plus, it can be hard to predict how things will play out. 

Still, depending on your personal finances and preferences, inflation and interest rates changes can influence decisions like whether to buy or sell a home, or tap into your home equity. These areas can also affect the decision between variable vs. fixed-rate loans.  

For example, if you’re taking out a home equity loan now, some homeowners might be more comfortable gaining the certainty that a fixed interest rate can provide. Even if interest rates rise elsewhere, once you lock in a fixed rate, you can keep your monthly payments and interest rate the same. Others, however, might prefer to still take a chance on variable-rate debt, such as if they want to take advantage of the lower upfront rates that these loans often provide, and then perhaps inflation and interest rates will settle down in the coming years.

Homeowners might also want to choose particular types of debt, like the Fraction Mortgage. This first-lien open line of credit differs from a traditional HELOC, as you get the money as a lump sum payment, with 5 year terms that can be renewed/refinanced as much as needed. That lump sum could be used in several ways, such as money for retirement, money for an investment or to consolidate debt, though keep in mind that you’re putting a lien on your home in doing so.

The Fraction Mortgage also provides flexible monthly payments* — you can even set it up to have no monthly payments at all — which could help in periods such as where inflation makes affording other monthly bills difficult.

With Fraction, you can unlock up to $1.5M of your home’s equity to use according to your needs. Get your free estimate today

Disclaimer: Information in this article is general in nature and not meant to be taken as financial advice, legal advice or any other sort of professional guidance. While information in this article is intended to be accurate at the time of publishing, the complexity and evolving nature of these subjects can mean that information is incorrect or out of date, or it may not apply to your jurisdiction. Please consult with a qualified professional to discuss your specific situation and confirm any information.