Here’s How Inflation Could Affect the Value of Your Home

As inflation rises, so do mortgage interest rates—causing house prices to fall. Here's how Excel's PV function can help you to estimate what your new house price will be.

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November 5, 2021

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As inflation rises, so do mortgage interest rates—causing house prices to fall. Here's how Excel's PV function can help you estimate what you new house price will be.Inflation is rising in the U.S. And that made me wonder how a higher rate of inflation could affect the price of real estate.

Let’s assume that a family can afford to make a 10% down payment on a new house and pay $1,200 per month on a 30-year loan. Yesterday, the Federal Reserve Economic Database, FRED, showed that the average mortgage rate in the U.S. was 3.09%. We can download their CSV file and then use Excel’s PV function to learn the maximum price the family can afford for their new house.

Here’s the PV function’s syntax:

=PV( rate, nper, pmt, [fv], [type] )

To calculate the amount they can afford to borrow, we can ignore PV’s optional arguments, which gives us:

=PV( .0309/12, 360, -1200 ) equals: $281,377

And with a 10% down payment, here’s the maximum price they can afford to pay for a new home:

=$281,377 / (1-10%) equals: $312,642

We now need to decide what interest rate is likely if our inflation continues. One way to do this is to average the mortgage rates since November 5, 1971 in the FRED workbook. That tells us that the average mortgage rate over the past 50 years was 7.8%.

We now can use this rate in the previous formula, like this:

=PV( .078/12, 360, -1200 ) equals: $166,697

And therefore, when inflation drives interest rates back to their 50-year average, the maximum amount the family can pay for a house is:

=$166,697 / (1-10%) equals: $185,218

If we assume that anyone who buys real estate goes through a similar calculation, when inflation drives interest rates to return to their 50-year average, the price of real estate could fall by:

=1 – $185,218 / $312,642 equals about 41%.

That is, when interest rates return to their 50-year average, the price of real estate could fall by about 41%!

Then I wondered what inflation rate could produce an average mortgage rate of 7.8%.

For a quick-and-dirty answer, I went to FRED’s page with the Consumer Price Index. I downloaded their CSV file with that data. I calculated the annual growth rates of the CPI by month over the past fifty years. That is, I calculated the monthly inflation rates of the CPI. And finally, when I averaged those monthly rates, I learned that over the past 50 years the average inflation rate has been 3.9%—an average that includes eleven months of deflation, starting in December 2008.

And in September 2021, the data told us, the U.S. had an inflation rate of the CPI of 5.4%.

That is, September’s inflation rate for the CPI already is higher than the CPI’s 50-year average. So why aren’t mortgage rates already at or above the 50-year average?

The simple reasons is that the Fed controls interest rates, and they’re keeping U.S. interest rates low. But over time, as inflation rises, mortgage rates—among other interest rates—will eventually rise.

And that strongly suggests that real estate prices will fall—perhaps by at least 40%.

And finally, what if inflation rates and mortgage interest rates rise to one standard deviation above the 50-year mean? As the top section of this table shows, that would give us an inflation rate of 6.9% and mortgage rates of 11.1%.

And, as the bottom section shows, that would drop the maximum home price the family could afford by 56%, down to $138,905.

In short, whatever you think your home is worth today, it could be worth 40 to 50 percent less over the next year or two.

Welcome to rising inflation!

You can download the workbook here.