Inflation is the enemy of low mortgage rates, which makes the current economic cycle wonderful for consumers looking to purchase or refinance a home.
According to the Federal Reserve, inflation rates have been persistently low and continue to run below the group's longer-term target of 2% per year.
Current inflation rates are far below this target, based on the most recent Consumer Price Index (CPI) report, which is published by the government.
More commonly called "The Cost of Living Index", CPI has fell short of the Fed's two percent target since mid-2014. And, today, with gas and energy costs down, it's unlikely that inflation will spike.
With inflation rates low, mortgage rates are expected to stay the same. Home affordability will rise and million of U.S. homeowners will be in position to refinance to lower rates.
Have you seen today's low mortgage rates?Click to see today's rates (May 27th, 2016)
U.S. mortgage rates are closely linked to the rate of inflation in the economy.
Inflation is an economic term. It is the rate at which the price of goods change.
As an illustration of how inflation works "in real-life", consider how the cost of milk has changed since 12 months ago.
Today, it requires more dollars to purchase a gallon of milk today as compared to one year ago. In conversations, as consumers, we express this as "milk is more expensive than it used to be."
Economists, however, view the change in the price of milk differently.
To an economist, it's not that the milk got more expensive -- it's that the dollars we use to buy the milk isn't worth as much as it used to be. Same product, more currency required.
This is inflation. It's everyday items costing more because the value of our currency has eroded. And, it's this erosion that explains the link between inflation and mortgage rates.
U.S. dollars are worth less when there's inflation in the U.S. economy. Therefore, everything denominated in U.S. dollars is necessarily worth less, too.
This includes mortgage-backed securities (MBS), which are the basis for current mortgage rates on all of today's common home loans.
FHA loans, VA loans, and USDA loans, for example, feature mortgage rates based on mortgage-backed securities, as do conventional loans made via Fannie Mae and Freddie Mac; and, these loan types account for more than 90% of today's housing market.
Here's the mortgage rates/inflation connection:
When inflation rates rise, then, the value of mortgage-backed securities drops for investors because the underlying currency for the bond has experienced an erosion in value. This erosion affects demand for the bonds negatively, which leads MBS prices lower and mortgage rates up.
Conversely, when inflation rates fall, the value of mortgage-backed securities grows because the bond's underlying currency is now worth more, relative to prior months. This, too, affects demand -- but in a good way.
Bond prices rise when inflation rates drop, which causes rates to fall.
This is why it matters that today's inflation rates are running below the Fed's target of 2 percent per year; and, below economist projections.
Wall Street wasn't expecting a low Cost of Living Index. Demand for MBS is surging. Mortgage rates are dropping, as a result.Click to see today's rates (May 27th, 2016)
The causes of inflation have been a matter of debate for centuries, with no clear consensus among the world's economists -- historical or current day.
However, inflation does exist and its runaway growth can present problems within an economy.
This is one reason why the job of "keeping inflation rate stable" falls to the Federal Reserve, our nation's central banker. It's one of two jobs that the Federal Reserve performs.
The group's first responsibility is to foster maximum employment. Its second is to maintain stable pricing.
The Fed deems an inflation rate of two percent to be "stable". Sustained inflation rates above two percent are considered too high over the long-term, and sustained inflation rates below two percent are considered too low over the long-term.
The latter scenario is sometimes known as disinflation, or deflation.
Deflation is the opposite is inflation. During periods of deflation, prices fall over a period of a time (or, the dollar's strength increases, depending on your viewpoint).
Falling prices may appear to be a good thing, but the effect of deflation on an economy can be as insidious as its opposite -- inflation.
In deflationary period, with prices in a downward spiral, consumers tend to "put off" any major purchases because all around them, prices are falling. "If I just wait," they say, "I can buy this thing cheaper".
As consumers put off purchases, supplies mount, which upsets the demand-supply curve and causes prices to fall even more. This restarts the cycle and prices eventually drop again.
Low inflation rates concern the Federal Reserve.
Especially because the group eased the throttle on its main inflation-inducing tool -- the Fed Funds Rate -- at the end of 2015; and, because energy costs are as low as they've been in a decade.
There are fewer forces to push inflation rates up today which makes disinflation a distinct possibility. If you're shopping for mortgage rates, this will lower your overall cost of homeownership.
Today's mortgage rates are near their lowest levels of the year. Low inflation rates and a softening U.S. economy have helped to boost affordability, and have opened refinance opportunities nationwide.
Get today's live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.Click to see today's rates (May 27th, 2016)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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2016 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)