Like most Americans, you probably fill your car up with gas every week or so, and have probably noticed that the long, beautiful slide in gas prices has recently reversed course. What you may not realize is that those higher prices at the pump may be sending mortgage rates higher.
Mortgage lenders are highly sensitive to inflation, and oil prices are an important component of inflation. So, when oil prices start to rise, it should put anyone interested in the mortgage market on alert - and that includes would-be buyers, sellers, and homeowners.
Mortgage Rates and Inflation
What do oil prices and mortgages have to do with each other? The link is inflation.
When a lender makes a loan, the interest charged is supposed to cover three things: inflation, default risk, and the lender's profit margin. According to the Bureau of Labor Statistics (BLS), inflation has averaged 4.11 percent over the past 50 years. With today's mortgage rates below four percent, they would seem to leave less room than is needed to cover a normal rate of inflation, let alone default risk or profits.
However, low mortgage rates have been made possible by the fact that the inflation rate has been unusually low in recent years - in fact, for the 12 months ending in January of 2015, the inflation rate was actually negative, at -0.1 percent.
Today's mortgage rates are highly dependent on unusually low inflation. If the inflation environment should change, expect mortgages to quickly follow. This is where oil comes into the picture. Oil prices are an especially important component of inflation because they represent a significant portion of consumer expenses and they affect the cost of many things consumers buy.
So, when oil prices make a move, the mortgage market pays attention. And recently, oil prices have changed direction.
A Change in Direction
According to the US Energy Information Administration, the price of a barrel of oil dropped by nearly half during the last six months of 2014. The slide continued in January 2015, with oil prices losing another 9.4 percent in a single month. Economists fretted about what this meant for the weakening global economy, but consumers accustomed to gas price shocks in the other direction could only cheer.
However, things began to change in February. Oil prices stabilized and turned slightly upward. The reaction of gasoline prices was even more pronounced -- prices at the pump jumped by about 14 percent in February, their first monthly increase since last June.
How significant is this to the overall rate of inflation? Well, according to the BLS, while the overall inflation rate was -0.1 percent for the year ending January 31, 2015, the inflation rate excluding energy costs was two percent higher, at 1.9 percent. This is indicative of where the inflation rate would have been without the extraordinary drop in oil prices. If oil prices have really stopped falling, expect inflation to rebound to about that level, or perhaps higher if oil prices rise quickly.
In short, it is reasonable to expect that inflation could be higher over the next 12 months by 2.0 percent or more. Mortgage lenders might be expected to absorb some of that higher cost, but not all of it. Therefore, if oil prices have reached a turning point, mortgage rates probably have as well.
Rising Oil Prices Increase Home Costs
There is little you can do about how gas prices fluctuate from week to week, but the nice thing about mortgages is that they allow you to lock in rates for years to come. So, with rates currently low but under pressure from rising oil prices, this might be time to act -- whichever side of the housing market you represent:
- Would-be buyers should make their home searches a priority so they can commit to a mortgage as soon as possible - and favor fixed-rate over adjustable-rate mortgages.
- Current home owners thinking about home improvement projects might want to get a home equity loan or line of credit soon, before rates rise and make it more expensive.
- Home sellers may want to get their homes on the market before rising rates start to weaken the pool of prospective buyers, and possibly depress home prices.
Let's face it - rising oil prices are probably going to cost you at the gas pump. However, you can make sure they don't cost you on the mortgage front as well, if you act before rates rise.