The Impact of Inflation for Mortgage Holders - An article looking at the impact of monetary easing on the mortgage market, and more specifically mortgage interest rates. Mortgage protection insurance suggestions are also provided.
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.
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