How does inflation impact homeownership?
While inflation wreaks havoc on your grocery bills and bond investments, it’s not all bad news for homeowners. But does the good outweigh the bad for existing property owners?
Before you get too nervous or excited about inflation, ensure you understand how past periods of inflation have impacted homeowners — the good, the bad, and the ugly.
Is Inflation Good for Homeowners?
Inflation can help homeowners in some ways. But that doesn’t mean it’s all rainbows and butterflies, even in the narrow realm of your home costs and value.
The Good News
Like most commodities with inherent value, real estate offers excellent protection against inflation thanks to inevitable value increases. But you get the most benefit if you have the right type of mortgage.
Home Values Appreciate
People need housing. When the value of the dollar goes down, people just have to pay more dollars for the things they need, such as housing and food. That means home prices go up.
Meanwhile, inflation also drives up the cost of building new homes, from materials to labor to land. That curbs new construction and makes existing homes more appealing in comparison, boosting demand and further lifting home prices.
Property owners end up with homes worth far more than they paid. They can borrow against that newfound equity if they want to pull cash out of their homes without selling. Or they can sell to cash out with a hefty profit.
Fixed-Rate Mortgage Payments Stay the Same
If you have a fixed-rate mortgage, even as your property value skyrockets, your mortgage principal and interest payments stay fixed. Over time, it feels smaller and smaller, as the real value of each dollar shrinks.
The hotter inflation runs, the lower your monthly payment seems and the faster your home appreciates. Your mortgage payment remains stuck in a time warp based on the value of the dollar when you bought your home, even as your home keeps growing in value.
After all, according to data compiled by the St. Louis Federal Reserve, the median home cost $120,000 in 1992 but costs $428,700 in 2022, a 257.25% increase.
That means the monthly payment on a median home 30 years ago is less than today’s car payment. No, really. If you borrowed $108,000 at 5% interest after a $12,000 down payment in 1992, your monthly mortgage payments would be $580, which you’d have continued paying at 1992 prices even as your home more than doubled in value.
The Bad News
Your monthly principal and interest might stay frozen in time, but that doesn’t mean your other ownership costs do. Inflation impacts homeowners in other ways too.
Your Property Taxes Go Up
You aren’t the only one who benefits when your home appreciates. Your local municipality is just as excited as you are, gleefully raising your home’s assessed value and therefore your property tax bill.
You can try appealing your tax assessment, but when your home really does go up in value, you owe more in real estate taxes.
Your Home Could Become Underinsured
If you bought your home for $250,000, you probably bought a homeowners insurance policy for a similar amount of coverage. Fast-forward five years later, and if your home now weighs in at $400,000, that $250,000 policy no longer covers you so well.
That means you need to buy more coverage, which in turn means a higher homeowners insurance bill. Shop around, negotiate, and use every other trick in the book to lower your homeowners insurance rate, but ultimately, you can expect to pay more when you need more coverage.
Maintenance & Repair Costs Go Up
There’s more to the cost of a home than the monthly mortgage payment, property taxes, and insurance. Homeowners shell out big bucks for maintenance and repairs year in and year out.
You must maintain and eventually replace every component of your home. Last year, it was the furnace. This year, it’s the roof, and next year, it’s the air conditioning condenser. You need to budget for these costs because they aren’t the exception — they’re the rule. It’s one reason homeowners need a larger emergency fund than renters.
And when inflation burns hot, these costs rise along with everything else. Plan on paying higher prices for everything from plumbing to painting and new windows to new wiring.
Variable-Rate Mortgage Payments Increase
The Federal Reserve responds to high inflation by raising the federal interest rate, which drives mortgage rates higher. That doesn’t affect you if you have a fixed-interest loan, but if you took out an adjustable-rate mortgage, your interest rate rises, which drives up your monthly mortgage payment.
Cooler Home Prices
As the Fed raises interest rates, it makes homes more expensive from the standpoint of monthly payments. Mortgage lenders cap borrowers’ loan limits based on the ratio of the monthly payment to their income, so higher interest rates also means lower loan limits for buyers.
As such, the average homebuyer can’t afford to spend as much on housing when interest rates rise. It can cool down housing markets, slowing appreciation and occasionally even sending home prices lower.
Higher interest rates can also push the economy into recession, another risk factor for housing prices.
Granted, that’s several dominoes down the line from high inflation. But the Fed does whatever it must to tame inflation, so white-hot inflation should give everyone cause for concern, even homeowners who benefitted from stronger appreciation.
The Verdict: Is Inflation Good or Bad for Homeowners?
All told, high inflation tends to help homeowners more than it hurts them — at least in lifting their home’s value and shrinking the real cost of ownership. Home prices don’t usually drop, even when the Fed raises interest rates, and non-mortgage expenses only cost homeowners so much in a given year.
Even so, jumps in inflation can lead many homeowners to feel trapped in their homes. That’s because the same downsides homebuyers face during inflationary periods apply to them if they plan to move, including higher interest rates on mortgage loans and higher monthly payments than they may have previously had.
Sure, they’ll collect a nice check when they sell their home, but they still need to move somewhere else. Whether they rent or buy, they’ll have to pay an equally inflated mortgage or rent payment for their next home.
That’s not the end of the world if they’re downsizing or moving somewhere with a lower cost of living, but it’s a barrier for anyone thinking about upgrading homes. It can also leave homeowners feeling locked in place and less willing to move to a new city for better job opportunities.
So while homeowners end up with a more valuable home with a lower effective mortgage payment, inflation still comes with costs, not all of them obvious.
Real estate ranks among the best hedges against inflation, rising in value just as fast as (or faster than) the dollar loses purchasing power. Real property has inherent value, regardless of the currency you use to buy it.
But the secondary costs of homeownership also go up accordingly, including property taxes, homeowners insurance, and maintenance costs. And when the Fed raises interest rates to combat inflation, that can also impact homeowners.
Enjoy the lower effective monthly payment and greater home equity while you live in your current home, but don’t get too smug. You’ll pay market pricing for your next home, and your current home equity will only cover so much of that cost.