How Inflation Affects Interest Rates

If you haven’t heard recently, people worldwide have become worried about the rise of inflation. In fact, The New York Times recently reported that 9 in 10 Americans polled said they’re concerned about this economic trend. But what is inflation, why should you be concerned, and how will it affect your interest rates—learn more below.

What is inflation?

According to the Federal Reserve, inflation is when the price of goods and services in general increases over time. This definition emphasizes “the general” price of goods and services. This part means if the cost of your jeans goes up but not the rest of the economy, it’s probably not inflation. The Fed uses several price indexes to determine the rate of inflation. Additionally, “increases over time” is equally significant. This is because the effects of inflation are gradual and aren’t shifting as quickly as other economic entities like the stock market. Think back to when your grandparent or parent would mention how they could go to the movies for less than a dollar. According to USA Today, the average cost of a movie ticket was $0.46 in 1950. The average price of a movie ticket reached $1.01 by 1965. The 1980s are known for having a high rate of inflation. In 1980, the average movie ticket cost $2.69, and by 1990 it cost $4.22, nearly doubling its price in just 10 years.

What is interest?

When borrowing money, a lender imposes an interest rate the borrower must pay each month in addition to the principal amount. Many loans offer variable interest rates, which means the rate will fluctuate with the market. Over the past two years, during the Covid-19 Pandemic, interest rates have been relatively low, which has been advantageous for those looking to buy a new home or refinance their current mortgages. This created “the Great Reshuffling,” when many Americans moved from big cities to smaller areas. However, inflation may begin to change this behavior.

What is the relationship between inflation and interest rates?

When the inflation rate rises, your purchasing power decreases. This means your money buys you fewer things. In addition, if inflation increases beyond interest rates, this means the interest money you accrue in your savings account is now earning less, and essentially, you’re missing out on the potential to earn more in interest. However, banks tend to raise interest rates on these accounts to combat this inequality.

This relationship also means the interest rate on your home’s mortgage will likely increase, making the borrowed money more expensive. Therefore, if you want to take out a mortgage or student loan soon, you might opt for a fixed rate and lock it in rather than a variable rate loan that will fluctuate with inflation.

How will this affect my current home mortgage?

If you already have a mortgage and haven’t refinanced yet, now might be your last chance depending on your current interest rate. Those with an interest rate higher than what’s currently available should undoubtedly consider refinancing. Those with an interest rate lower or equal to what’s presently available should continue paying their current loan. If you have a variable rate loan, consider switching to a fixed rate, so you don’t have to pay more for the money you’ve borrowed.

What if I’m considering purchasing a new home?

If you want to become a new homeowner and need financing, now is the time to get pre-qualified, find the house of your dreams, and lock in your fixed interest rate before its eventual rise. You can learn how you can win in this turbulent sellers’ market through our downloadable Whitepaper called “What Homebuyers Need to Know.”

In the meantime, if you have more questions about how inflation will affect your current or potential mortgage, reach out to one of our Loan Advisors for more information today.