How Does Inflation Affect House Prices?

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Whether you are in the market to buy or you’re looking to sell your home, it’s important to understand how macroeconomic trends can impact house prices. While housing prices can remain relatively static on an individual level, neighborhoods, cities and even regions will suffer fluctuations depending on the elements of the macroeconomic environment. With this in mind, one of the most important indicators you should keep in mind is inflation. Inflation will generally have an impact on the price of any good with limited quantities. Because there exists a finite number of homes in any given market, inflation will tend to have an impact. How does this work? Here’s a bit more information.

What is inflation?
You may hear this term thrown around by economic experts, but it is important to understand inflation as a concept. While some people think of inflation as just the increase in prices of goods in a market, this is an incomplete understanding of the term. Inflation is less of a problem itself and more of a symptom of another problem. Namely, inflation is what happens when the currency of a country is devalued. Typically currency will become devalued because the money supply grows. Those who control the money supply can choose to print more money. It follows then that the seemingly arbitrary printing of money would make the existing money in circulation worth less. Prices tend to rise as money is worth less.

The relationship between inflation and housing prices
With few exceptions, houses will behave like almost any other good when inflation hits. Houses are known as an asset good, which means that when inflation takes place, house prices will tend to increase by the rate of inflation. The amount of money you must put down on a house will also rise when inflation takes hold in an economy. It is important for buyers to time their moves right if they anticipate inflation, as inflation can impact the value of their mortgage payments.

Inflation and fixed-rate mortgages
If you have a fixed-rate mortgage and inflation hits, then you will benefit. The explanation for this is quite simple to understand. If a mortgage lender gives you a $300,000 loan at a fixed interest rate, that loan will be worth less money over time as the money supply increases. You will essentially get to pay back that fixed-rate loan with the new dollars. The cost of the mortgage becomes discounted in this scenario, as there will be more money available to make those payments. Normally goods adjust for the additional money supply by going up in price, but a mortgage of this nature is fixed, so lenders cannot increase the price. You benefit by paying back a loan that is locked in at pre-inflationary prices.

Inflation can have either a modest or substantial impact on house prices. Understanding this and timing your purchase properly can save you money and make your home purchase a much better investment. While it can be difficult to predict when inflation will hit, economists can make reasonable predictions to give you time to react.