The Impact of Inflation for Mortgage Holders

Author: James P White
Date: Feb 1, 2010 - 12:27:03 PM

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It is clear that the mortgage market has extremely close ties to the wider macro economy. The recent past has shown us that these ties are two-way, with sub-prime mortgage debt crippling credit markets globally. The impact of this can still be seen clearly in mortgage interest rates, which remain at historically high differentials from base rates (official central bank rates). These interest rates remain high to mitigate an increased level of risk in the personal home loan market. However, the sub-prime fall out may yet have its biggest (long term) impact on mortgage interest rates.

Central banks worldwide have pumped billions of dollars into their respective economies in order to prop up credit markets and stabilise economic growth. Central banks seem to have thrown their commitment to targeting inflation completely out of the window. The Fisher Equation tells us that an increase in the supply of money (caused by printing cash in this instance) will result in higher inflation as the economy adjusts to a new monetary base level. This rise in inflation is just starting to be witnessed, with the UK currently recording the highest monthly rises in inflation since the 1970’s.

At some point central banks will have to raise interest rates in order to stabilise inflation. If this happens mortgage interest rates are likely to rise also. This could cause some problems for floating mortgage holders. Mortgage interest rates are also likely to rise due to inflation itself. As inflation rises the real interest rate charged by lenders will decline, meaning that rates will have to rise in order for them to maintain the same risk-adjusted return.

If official central bank interest rates increase this will have a significant negative impact on economic growth and likely cause another wave of redundancies. In this respect central banks are between a rock and a hard place, with inflation on the one hand and possible recession on the other. In any case, these are uncertain times for mortgage holders. Although mortgage payment protection insurance can protect home loan holders from unemployment, the insurance market cannot cover missed payment due to the burden of higher mortgage interest rates. For new home buyers, taking out a fixed rate loan would probably be a wise move.

This article was produced by James P White of Drewberry Personal Mortgage Protection Insurance, specialist providers of information, advice and broking services in the mortgage life insurance and mortgage payment protection insurance markets.

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