How Does Inflation Affect a Mortgage?

When you go shopping for a mortgage there are two basic things you will want to know. Firstly, you want to know if you can qualify for a mortgage (more specifically, how much can you qualify for). Secondly, you want to know the interest rate you will be charged on that mortgage. In many ways, the answer to those questions is related to the rate of inflation.

In a low inflation environment overall interest rates tend to be low and you can usually get a very favorable interest rate when you borrow money to finance a home. In contrast, when inflation is high mortgage interest rates rise, reflecting the current market conditions and lending environment.

Fixed Rate Mortgages

When you take out this type of mortgage, be it for 15 or 30 years or some other term, you pay the same interest rate throughout the life of the loan. The inflation rate only really matters when you acquire the loan. Interest rates will be offered based primarily on the current cost of money, but, they may have a component based on anticipated inflation rates in the future. If, during the course of the loan’s life, inflation causes interest rates to surge, you are protected. Your rate will not change.

Adjustable Mortgages

This type of mortgage is very much influenced by the rate of inflation. An adjustable rate mortgage starts out with a lower interest rate than a fixed rate mortgage for a fixed period of years and then adjusts annually to reflect the current interest rate and inflationary environment. Such a mortgage is tied to a standard index that measures inflation and if inflation is not well-controlled, the monthly payments on your adjustable rate mortgage could rise dramatically.

Ability to Refinance

Individuals may want to consider refinancing for several reasons. A homeowner may have an adjustable rate mortgage that is about to adjust higher and want to refinance at a fixed rate to keep their mortgage payments at a manageable level. If you have a fixed mortgage with a high interest rate and there is a period of low inflation, mortgage rates will come down.

Depending upon a number of factors, it may be beneficial for you to pay the closing costs to refinance at a lower rate and perhaps cash out some equity at the same time. High inflation inhibits the ability to refinance. Low inflation makes the option available to a wider group of mortgage holders.

Second Mortgages

Banks and other mortgage lenders are very sensitive to inflation rates when it comes to making money available for second mortgages. In an inflationary environment, it is true that interest rates will probably move higher. It is also true that the market value of your house will also appreciate, which leads to greater equity for the homeowner. A bank will look at the debt/equity ratio as well as other factors in their decision to approve a second mortgage. A high debt to equity ratio will make it harder to borrow.  If inflation boosts the market value of your home, you will lower your debt/equity ratio and be more apt to be approved for a second mortgage.

Cashing Out

When it comes time to sell your house, it is not particularly relevant to the homeowner what the inflation rate happens to be. Once a sale has been made and the mortgage paid off, the issue of inflation does not apply to that mortgage. However, in cases where you have an assumable mortgage that is at a favorable interest rate to the current mortgage rate environment, it can be a good selling point and actually increase the price you can get for your house.

Should You Really Worry About Inflation When Getting a Mortgage?

The answer to this question depends primarily on the type of mortgage you get. On fixed rate mortgages, there is less risk and you know what your principal and interest payment will be every month. On an adjustable rate mortgage, you can be exposed to great risk of higher monthly payments if inflation rears its ugly head in the future when rates can be adjusted.

This article was written by Angela Stone on behalf of 12 Month Loans, a website where you can learn all the things you need to know before applying for a loan!

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