Do mortgage rates go up with inflation?

by Helana Mulder on 05 Dec 2021

Home buying and economics seem to be at the forefront of everyone's mind lately, and with that comes discussions of inflation, interest rates, and mortgages. As the economy continues to recover after the damages that the Coronavirus pandemic caused, rising mortgage interest rates don't seem too far away.

While other factors are definitely at play in the forecast of higher rates, it's important to really understand the two concepts and their relationship.

Defining inflation and mortgage interest


Inflation refers to the decrease in purchasing power over time. In other words, it means that the value of currency decreases and can buy less than it could in the past. Inflation can be seen in the rising prices of goods and services and the actual face value of a country's currency. For example, where $20 might have bought you a whole cart full of groceries several years ago, it now might get you a few key items as the prices have increased.

Inflation can also be seen in action through massive government spending. As the government worked to put money in the pockets of consumers through COVID relief cheques, inflation started to spike as well. Raw materials and the cost of goods sold (COGs) increased, leading to supply chain shortages and more expensive consumer goods.

The Consumer Price Index (CPI) and the Wholesale Price Index (WPI) are two of the most commonly used indexes used to monitor the rate of inflation.

Three types of inflation

There are three main types of inflation:

  • Cost-Push: the COGs and production materials increase which then leads to higher prices. The demand for the product remains the same, but the supply decreases.
  • Demand-Pull: a product's price increases because there is a high appetite (and often lower supply) among consumers.
  • Built-In: as the cost of living increases, workers and individuals push for higher wages at work, you can expect inflation to increase along with it.

Interest rates

Interest is the amount of money that borrowers must pay for the act of loaning money. It is also referred to as a cost of borrowing and is expressed as an annual percentage rate (APR).

Interest rates are a key tool in the tool kit of monetary policy used by a central bank. The central banks in North America are the Bank of Canada and the Federal Reserve System (commonly referred to as the Fed).

The Federal Open Market Committee, which is a group of central bankers in charge of monetary policy and open market operations, seeks to promote economic growth in the Federal Reserve Bank.

Because the central bank sets the overnight rate at which banks and other lending institutions borrow money, their rate has a dramatic effect on the economy of their country. Low-interest rates can be appealing to economists as they encourage spending among consumers and investors, thus generating more economic growth and prosperity.

In real estate, interest is specifically important when it comes to mortgage rates.

Mortgage interest rates

When taking out a mortgage to buy a house, you have to think about the amount of interest you will be paying on your loan (the mortgage interest rate).

Mortgage rates usually fall under one of two main categories: variable and fixed-rate loans. As the names suggest, a variable rate is subject to change while a fixed-rate stays the same for a predetermined amount of time.

An inverse relationship

One of the first things you should know about interest rates and inflation is that they have an inverse relationship. This means that when the economy is growing, inflation rates are high while interest rates are low. On the opposite side, as the economy declines and interest rates rise, inflation rates will decrease.

The housing market and inflation

Just as the prices of goods and services increase when inflation goes up, so do the price of homes. This is because the services and raw materials associated with home buying and building have to adjust to rising inflation. For example, if it costs a construction company more to build a home, the housing prices will increase as well.

A fixed-rate mortgage

One way to combat rising rates is to take out a fixed-rate loan for your mortgage. While a fixed interest rate can have its own downfalls, locking into a lower interest rate for a few years while inflation rises can end up saving you some money in the long run.

For example, many mortgage rates during the summer of 2021 were actually lower than the rate of inflation. While you could get variable-rate mortgages that were very low, homeowners could also lock in with a fixed interest rate while they were low. This meant that even as interest rates and inflation increased, the mortgage interest would remain the same until the end of the term.

Even though these rates are low, it's important to remember there's no such thing as a free lunch. There will always be costs and risks associated with borrowing and investing.

Prime example: The Great Recession

One important example of this concept is the 2008 financial crisis as the housing bubble burst. Mortgage-backed securities (MBS) were being heavily marketed by mortgage brokers as a riskless reward for investors- a free lunch - when really they were very unstable. These MBS were exposed as being risky investments and as the mortgages defaulted, so did the investments.

Current mortgage and inflation rates

As we've seen this past summer, the average rate of a mortgage was lower than the inflation rate for the first time in over 40 years. Even though home prices were seemingly increasing every day, mortgage rates were some of the lowest we'd seen in years.

This had a lot to do with the economy recovering from the recession sparked by the COVID-19 pandemic in 2020. So, as economic growth continues to increase, we can likely expect interest rates to start to rise as well.

A cooling economy?

Recently, we've seen the real estate market start to cool off as home prices level out and interest rates slowly start to rise again. The Federal Reserve and the Bank of Canada are likely to raise interest rates to adjust to more inflation. This would also mean higher mortgage rates. However, even with higher mortgage rates, it's likely that it will take some time for the housing markets to completely cool and for the appetite to decrease among buyers.

Some warning signs

Along with the markets cooling off, there are some things that have economists worried. One of these issues is runaway inflation, which is when there is a high inflation rate that continues to rise. If the rate of inflation starts to get out of control, it will force the central banks and the bond market to make changes in order to take control of the rates.

A positive note

While raising interest rates seems inevitable as we continue to recover from a recession and adjust to inflation, there are still some ways to take advantage of low rates and prepare for higher interest rates. You may consider refinancing your home and lock in with a lower mortgage rate before they start to spike back up.

Also, while low-interest rates encourage consumers and investors to spend, increased rates will actually make it more advantageous to save. Consider opening a high-interest savings account and let the bank pay you.

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