How Does Inflation Impact Home Prices?
Inflation impacts almost everything in the economy, causing prices to rise over time. Housing is just one of the things it impacts, and given the recent high inflation, it’s reasonable to wonder what will happen to home prices, especially if you’re in the market to purchase a home.
Key Takeaways
- Generally, rent has kept pace with inflation as measured by the Consumer Price Index, while home prices have risen faster than inflation.
- Housing is a highly regional market, so some areas see price changes much more rapidly or to a greater extent.
- Home prices also tend to rise faster than incomes, meaning homes have become less affordable.
- Prices have fallen slightly in recent months as rates have risen.
Inflation and the Consumer Price Index
When you hear people talk about inflation, they usually discuss it by saying that prices rose by a specific percentage. This is a relatively easy-to-understand way of discussing price increases, but it misses some key nuances.
In the United States, the Consumer Price Index (CPI) is a key measure of inflation. It tracks the change in price paid by consumers for a basket of consumer goods. However, not every product in that basket of goods will see the same change in price.
For example, in the 12 months ending in May 2023, the CPI rose by an average of 4%. However, some things rose in price and others fell. Food prices rose by 6.7%, and electricity rose by 5.9%, but gas fell by 20.4%.
Not everything moves in lockstep with the average rate of inflation. Changes in housing prices tend to be influenced by inflation, but they don't perfectly follow overall inflation trends.
Factors That Have Led to Increases in House Prices
A variety of factors influence housing prices. No single factor is the sole cause of rising costs.
Supply and demand is one of the key factors. There is a finite amount of space to build housing, yet the population of the United States has grown significantly over the past century.
Other influences include a low supply of affordable housing and zoning regulations that make constructing new housing, especially high-density housing difficult.
The pandemic has also played a role, boosting the prices of commodities, including those used in home construction. For example, lumber rose in price by 114% between May 2020 and May 2021. Rising demand for space to work at home and growing interest in moving from cities to suburbs also created higher churn levels, which can boost housing prices.
Inflation vs. Housing Prices Over Time
Increases in housing prices have historically outpaced inflation, meaning that homes have become more expensive over time, even when adjusting for the impact of inflation.
Since 1963, the first year for which the Federal Reserve Bank of St. Louis has data on housing prices, the Consumer Price Index has risen from 30.44 to 303.294, an increase of 896%. During that same time, the median sales price of a home rose from $17,800 to $436,800, an increase of 2,353.93%.
CPI and Housing Prices
Since 1963, inflation has risen 896%, while housing prices have risen by more than 2,350%. During that same time, rent rose by 892%. That means rent has held pace with inflation, while homes have seen significant price increases, even when adjusted for inflation. However, given the regional and local characteristics of the rental market, some areas may have seen rents rise at rates faster than inflation.
However, home prices are just one piece of the puzzle when determining the price of housing. Roughly a third of people in the United States or about 36%) rent, rather than own, their homes.
Since 1963, the CPI for rent rose from 40 to 396.726, an increase of 891.82%, roughly the same as inflation.
In short, the price of homes has increased at a rate greater than inflation, while rents have largely kept pace with inflation. However, it's worth noting that rents are highly regional, so some areas have seen affordability change more than others.
In the past few years, there have been significant upheavals in both inflation and housing prices, thanks in part to the impact of the pandemic.
Housing saw a major price spike, with the Case-Shiller National Home Price Index jumping by 18.6% between September 2020 and September 2021, the strongest year of growth on record.This index tracks changes in the purchase price of single-family homes in the U.S., updated on a monthly basis. It does not include multi-family homes or newly constructed homes.
Rental prices fell slightly but recovered quickly and rose above pre-pandemic trends. Rents continued to spike through 2022, at one point seeing more than 17% year-over-year increases, though they have calmed in recent months.
Housing Prices vs. Income
Inflation causes the price of goods to rise over time, but if incomes keep pace with inflation, consumers’ purchasing power is largely unaffected. So long as incomes rise with inflation, the impact of increases in housing prices feels less painful to consumers.
In 1963, the median family income in the United States was $6,249 annually. In 2021, that number reached $88,590, a rise of 1,317.67%, well below the increase in the price of a home but outpacing the rise in rents.
That means that over the past 60 years, buying a home has generally become less affordable because incomes have not kept up with the price of homes available for sale. However, renting has gotten slightly more affordable because incomes have risen by more than the typical rent.
Remember that this is on a national, not regional, scale and reflects long-term change over 60 years. In recent years, rent increases have been vastly higher than income increases. And some areas might have seen very different changes in income and home prices.
For example, between 1984 and 2021, home prices in Massachusetts rose by 469.89% while incomes increased by 221.10%.
Nationally, incomes rose by 235.15% and housing prices by 372.89%, meaning that residents of Massachusetts saw housing get significantly more expensive relative to income compared to residents of some other states.
Inflation and Interest Rates
A common response to high inflation is for the Federal Reserve to raise interest rates. Increasing rates encourages saving and discourages borrowing, which can help slow down the economy and reduce the rate of inflation.
Since the Fed began raising rates in early 2022, the Federal Funds Rate has increased from roughly 0% to about 5%. Rates for other loan products, including mortgages, have also risen.
In addition to the actual price of homes, interest rates play a huge role in determining the affordability of housing. The majority of homeowners, about 63%, have a mortgage on their home. As interest rates rise, the required monthly payment on mortgages also increases, making homes harder to afford.
In January 2020, the average interest rate on a 30-year, fixed-rate loan was 3.72%. In July 2023, it was 6.81%.
If someone purchased a home for the median price in January 2020, they would have paid $329,000. If they financed the full amount at the average rate at the time, their monthly principal and interest payment would amount to $1,518.
Financing a home at July 2023’s median price of $436,800 at 6.81% would result in a payment of $2,851. Despite the price of a home increasing by about one-third, the monthly payment nearly doubled due to higher rates.
This means that high inflation, and the policy changes that aim to fight it, have a compounding effect on housing affordability. Home prices tend to rise faster than inflation and high interest rates greatly increase monthly housing costs.
The Future of the Housing Market
If you’re in the market to buy a home, there are both reasons for hope and reasons to worry.
On the one hand, housing prices spiked during the Covid-19 pandemic, but have decreased very slightly. Between Q4 2022 and Q1 2023, the median home price dropped from $479,500 to $436,800. If prices continue to cool, that could be good news for homebuyers.
However, interest rates are high, meaning homes would need to see significant price reductions for monthly mortgage costs to return to the levels they were at just a few years ago. Rates are likely to remain high for some time, or even increase further given Federal Reserve chair Jerome Powell’s statement that another rate hike is likely by the end of the year.
Home-Buying Tips
If you’re in the market to buy a home, it can feel overwhelming, especially given the high home prices and interest rates in recent years.
There is some hope given the decrease in median home prices between Q4 2022 and Q1 2023, but it’s unclear if that trend will continue. Also, keep in mind that housing is a very regional market. Some in-demand areas might see prices rise even while the national average falls.
Massachusetts is one such area. The all-transactions house price index rose by 0.9% between Q4 2022 and Q1 2023 compared to the large fall in the national median home price.
Given the odds of future increases in interest rates and the uncertainty of future price movements, it may be a good idea to try to buy sooner rather than later. If rates fall in the future, refinancing your mortgage to a lower rate is an option.
You’re not locked into a high rate. This makes buying with a high interest rate, assuming the payment is still affordable, less financially painful than waiting and seeing home prices rise.
To make it easier to afford a home, look into local homebuyer programs. Many areas have special opportunities, especially for low-income or first-time homebuyers. For example, Los Angeles offers low-cost loans to help low-income, first-time buyers afford the down payment on a home.
Many banks also have discounts available for first-time buyers. Check with your local government and lenders to see what programs are available.
You should also be aware of the different mortgage programs out there. Conventional loans are just one type of loan that you can use to buy a home. If you can qualify for a VA loan through military service or a USDA loan by buying a home in a qualifying rural area, you can benefit from low down payment requirements and easier underwriting.
Most people with fair or good credit and reasonable amounts of debt can also qualify for FHA loans, that only ask for a 3.5% down payment, which may make homeownership more achievable.
Who Benefits from Inflation in the Housing Market?
Generally, homeowners, especially those with mortgages, benefit from inflation. The value of homes tends to increase faster than inflation, so their investment does not lose value. At the same time, their mortgage balance does not change, so the amount they have to repay to pay off the loan is worth less relative to when they got the loan.
Is Inflation Good For Real Estate?
Real estate is often seen as a good hedge against inflation given that it increases in price at a rate faster than inflation. That means that inflation can be a good thing for people who own property.
How Does Inflation Impact Mortgage Rates?
Typically, the Federal Reserve attempts to reduce inflation by raising interest rates. That means that rising inflation usually leads to mortgage rates increasing. Higher mortgage rates, in turn, increase the monthly housing cost for people who borrow money to buy homes.
What Happens to House Prices During Recessions?
Generally, during recessions, housing prices fall or hold steady. This reflects reduced demand because fewer people can afford to move to a new home.
Who Benefits From Inflation?
Inflation tends to benefit people who have debt because they can repay those debts using money that has lower purchasing power than the money they initially borrowed. That means inflation can help current homeowners with a mortgage. Savers see a negative effect from inflation as their savings loses purchasing power.
What Are The Worst Investments During Inflation?
Cash and long-term fixed-rate investments like bonds tend to be some of the worst-performing assets during inflation. This is because the interest that you earn may not be sufficient to keep up with inflation, leading to a potential loss of purchasing power.
Bottom Line
Historically, housing prices have outpaced inflation, meaning that homes have become more expensive on a real basis. If you're in the market to buy a home, that may mean you have a good reason to try to buy sooner rather than later. The longer you wait, the more home prices could rise, putting a home purchase out of reach.
On the other hand, renters have historically seen prices increase at a similar rate to inflation. Though rent can be volatile, over the long run, it has remained largely affordable, so renters do not have to worry about long-term inflation as much as those who want to buy a home.
