How Does Inflation Affect Mortgage Rates?

The good news is that home prices have settled down in most parts of the country. Stable prices make home buying more affordable for more people.

The unknown that remains for home buyers: mortgage rates. Specifically, how mortgage rates can affect your debt-to-income ratio.

Mortgage Rate, Debt-To-Income Ratio Are Connected

When you are concerned with rising mortgage rates, keep an eye on the inflation rate.

The Federal Reserve significantly controls mortgage rates through the federal funds rate, commonly called the prime rate.

The Fed adjusts the interest rate for two primary reasons. 

The first is to stimulate a weak economy by making it easier to borrow money; this is typically when interest rates are lowered. The second it to keep the economy from overheating, which causes inflation to spike upward. When inflation is high, interest rates are raised to cool the economy.

Both reasons drive mortgage rates and ultimately affect your debt-to-income ratio.

The debt-to-income ratio is a percentage telling lenders how much money you spend versus how much money you have coming into your household.

When mortgage rates increase, your monthly house payment is higher. You have less to spend on other necessities and luxuries. The bottom line when you’re applying for a higher rate mortgage is that you might not be able to afford as expensive of a house versus when mortgage rates are lower. 

Inflation Also Affects Debt-To-Income Ratio 

Separate from mortgage rates, inflation directly affects your debt-to-income ratio. This is because your other necessities and luxuries cost more as inflation rises.

When you have to pay more for groceries and your car payment, you have less remaining for the mortgage payment. High inflation also causes the cost of houses to increase.

A low inflation rate will bring down the mortgage rate, which makes buying a home more affordable.

Until it doesn’t.

This is the more complicated part: too low of an inflation rate means the economy is stalling.

The economy stalls when consumers don’t have enough money to spend, which is why interest rates are lowered. At the same time, a weak economy and low consumer spending lead to higher unemployment rates.

This is because businesses aren’t making enough money due to low consumer spending. When business don’t make money, employees are laid off.

Why You Don’t Want Zero Inflation

If you’re among the unemployed, it definitely affects your debt to income ratio. You might even be living on borrowed credit, which leads to more debt than income.

The goal of the Federal Reserve is to keep the inflation rate as close to 2% as possible. When inflation is much above 2%, interest and mortgage rates will rise.