We are often asked about the effect rising rates have on mortgage payments.
Most of this concern has to do with how the Federal Reserve is treating interest rates.
However, a component of the interest rate is the rate of inflation.
The following article written by Lawrence Yun, the chief economist of the national Association of Realtors, does a great job of explaining what causes inflation to rise, and why higher inflation leads to higher interest rates, and how that in turn leads to much higher mortgage payments.
The following article was taken from the September/October 2013 edition of Realtor magazine:
The most recent U.S. inflation rate has clocked in at a manageable 2 percent.
This level is not inherently worrisome for consumers.
But pressure is building, and rates are expected to trend higher.
Apartment rents and homeowner equivalency rents (a fuzzy hypothetical figure of what homeowners would pay to rent out their homes) are both increasing more than 2 percent annually and could soon approach 3 percent.
Persistent housing shortages and falling rental vacancy rates are behind the rising rates.
Because housing costs make up the largest part of the consumer price index, these increases are significant.
But other sectors contribute to inflationary pressures, too.
Medical costs, which have been rising more gradually in recent years (they should record their slowest price gain in 40 years in 2013) are likely to head back up.
Energy costs are also rising sharply. Crude oil prices are up 19 percent from a year ago, while natural gas prices jumped 23 percent.
The only component of the CPI that is falling pertains to electronic devices.
And even those are not absolute price declines. (If a new model sells for the same price as the old model, statisticians compute it as a decrease though consumers get no price break.)
So if inflation spikes from 2 percent to 3 percent, does this create a significant hardship for consumers or the overall economy?
More than you might think.
That’s because as inflation ticks up so do mortgage rates.
If inflation rises to 3 percent by 2015, which is more likely than not, mortgage rates will have to rise by a full percentage point to compensate lenders for the loss in purchasing power of the money returned to them.
A one percentage point increase on a $200,000 loan will increase the monthly payment by $167.
On a $500,000 loan, the payment rises by $417.
So yes, inflation matters and it will accelerate in 2014 and 2015.
Factor this trend into your home buying and home selling decisions.