he housing market is piping hot. The U.S. saw its highest inflation in 40 years, and real estate is one of the sectors most affected. The covid pandemic pushed the U.S. economy into a short recession, but the real estate boomed amidst the crisis. The demand-pull inflation had led the housing market to a boom.

Though this inflation was a blessing for homeowners who accumulated equity faster, it was a nightmare for the potential buyers. The rising inflation put a question mark on the affordability of homes and posed a potential threat to the housing crisis like in the 2000s. But, how does inflation affect the housing market, and what is its impact on the interest rates? Read further to figure it out.

What Is Inflation?

Inflation is a general price increase in goods and services in an economy. It is a decline in the purchasing power of money. You probably have heard your parents saying how much they could afford with $1. But, now, due to inflation, that same dollar can only purchase a fraction of the goods and services that it was once able to.

Inflation characters

For instance, a gallon of milk costs $3.77 in 2021, which currently costs around $4.33 per gallon. This inflation is an increase of 14.9 % in a year. As a result, you will need $0.56 extra to afford the same gallon of milk. Likewise, inflation has decreased the purchasing power of people and increased the cost of living.

Inflation in U.S. Housing Market

Inflation in the U.S. housing market is at a whole new level. Home prices in the United States have risen 34.4 percent in the last two years, including a 19.8 percent increase in the previous year. That year-over-year increase is more than four times higher than the historical yearly average (4.6%) since 1987. According to the National Housing Report, the average home sale price hit a record in February 2022 at $345,000, which is 3% more than last month and 17.3% more than a year ago.

What Are The Causes Of Inflation In The Housing Market?

High Demand But Low Supply

As the general economic rule applies, the price rises when the demand is high, and the supply is low. The housing market was already experiencing a lack of supply and strong demand before the pandemic hit. The pandemic halted the construction of new homes, and the sellers took their homes off the market as they did not want strangers to visit their houses amidst the pandemic. The tenants had a hard time finding renting place due to this reason.

Furthermore, the pandemic taught people the importance a home plays with the stay-home protocol. A house was no longer a place to eat and sleep; it had also transformed into a school and office. Thus, many homeowners sought possibilities to trade up and expand their living space. Tenants also entered the housing market in a quest for their first home. This further surged the demand for houses. But compared to the increasing demand for homes, there was low supply, which resulted in the high house prices.

Strong Economy

The U.S. faced its shortest recession in history in 2020 but bounced back even more robustly. The GDP of the U.S. had dropped 3.4% in 2020, but it was able to shoot up 5.7% in 2021 – the highest growth rate the country has seen since 1984. Due to economic growth, people felt secure in investing in the real estate market, and hence, the demand jacked up.

Low Mortgage Interest rates

Mortgage interest rates also have a massive role in the price of houses. The lower the interest rate, the more affordable it is to purchase a home. Rates had been steadily decreasing for some time, but in 2020 they plummeted dramatically, hitting a record low of 2.65% in January 2021. As mortgage rates hit a historic low, people flocked to take advantage of the lower costs of buying a home.

Remote Working Environment

People tend to purchase houses nearby their offices. Thus, they buy small homes or rent rooms to stay close to their workplaces. But, with the remote working culture, people can now easily work from home. Thus, people are moving out of their modest houses and looking for bigger homes as they are spending more time in them now. This transition has also caused an increased demand for homes outside the core areas.

How Does Inflation Impact Housing Market?

Inflation is like a double-edged sword in the housing market. While due to the inflation, the house price sees an appreciation, increasing the profit and value for the homeowners. On the contrary, the prices of construction materials, finished products, or labor costs increase, resulting in a high cost to build and maintain a home. However, housing is typically seen as an inflation-protected asset as its value rises parallel with the inflation rate. Thus, if demand persists, inflation helps appreciate the house value for the homeowners but the home buyers, it decreases the affordability.

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But, there is a twist. Increasing inflation also means an increased interest rate, and it is not favorable for both homeowners and homebuyers.

How Does Inflation Impact Interest Rates?

Inflation and interest rates have an inverse relationship with one another. This means that when the interest rates are low, the inflation rises and vice versa. Usually, the Federal reserve bank uses the interest rates as a monetary tool to curb the rising inflation. For instance, the Federal Reserve intends to increase interest rates in 2022 to control the greatest inflation rate in 40 years.

When bank rates are high, the cost of borrowing money also rises decreasing the affordability for people and businesses, and they have less money to spend. This ultimately reduces the demand in the economy and controls inflation.

What Does A High-interest Rate Mean In The Housing Market?

High mortgage interest rates in the housing market will help cool down the hot housing market. Since the mortgage interest rate is high, the cost of buying a house increases. This decreases the demand in the housing market. When demand is less, the prices of homes fall. High-interest rates are not favorable for buyers and sellers in the housing market. For buyers, it decreases the affordability, whereas, for the seller, it decreases the profit and value of the house.

House Piggy Bank

For instance, Mr. A is looking to purchase a house, and he needs to pay a 4% interest rate on a 30-year fixed mortgage on a home worth $500,000. His monthly mortgage payment would be $2,148. If the mortgage interest rate increases to 5%, his monthly payment would rise to 2,416. Mr. A has to pay $268 more in his mortgage payment which is 12.47% more for a 1 % increase in the mortgage interest.

Thus, with the increase in interest rate, affordability decreases, and so does the purchasing power. Since houses aren't affordable, the buyers back out of the housing market, reducing the demand. When there are fewer buyers, the sellers need to lower their housing prices to sell them.

Interest Rates In The U.S. Housing Market

The mortgage interest rate had hit the historic low at 2.65 percent in January 2021. The low interest had a massive role in increasing housing demand. Thus, the Fed increased the interest rate to curb the increasing inflation rate. The average rate on a 30-year fixed mortgage rose to 5.30%, whereas the average rate on a 15-year mortgage increased to 4.60%. The Fed plans to continue raising the interest rate, and thus, the mortgage interest rate keeps on soaring. As a result, the housing market has seen a significant drop in homebuyers.


The average U.S. inflation rate is the highest in 40 years, and the inflation in the housing market is on another level with double digits increase rate. The housing market had been facing high demand but limited supply, but the pandemic worsened the trend. The imbalance of the demand and supply side of the housing market caused demand-pull inflation in the housing market.

The Federal Reserve had to step in and increase the interest rate to curb the rising inflation. The increasing interest rate meant high-cost borrowing, due to which many wannabe homebuyers stepped backed from the market, decreasing the demand and the price.


May 31, 2022

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