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What MLOs need to know about housing and inflation

Rob Chrisman
Insider
Rob Chrisman
A Mortgage advisor explains inflation to his clients

Top loan originators, whether at a depository bank, mortgage bank, brokerage, or credit union, all have a wide variety of tools at their disposal. And their jobs encompass a wide range of disciplines: marketing, sales, economics, small business administration, psychology, math, and organizational behavior all come into play on a daily basis in varying degrees. Good MLOs know what to focus on and where to spend time, and what isn’t as important for their clients. They also know how to use the tools, and enough about each discipline to help borrowers.

With this is mind, and as we move past the summer of 2021, one of the key topics influencing mortgage rates is inflation. Economists disagree (of course) as to the extent of current and possible inflation. But every MLO should be prepared to discuss the topic with their borrowers and explain it. After all, in today’s global economy, fears of inflation are front and center after the massive government stimulus in response to the COVID-19 pandemic. And so, we find MLOs being asked by clients about inflation, the direction of interest rates, and the economy in general. MLOs understand that their clients should comprehend the ins-and-outs of inflation, how it might impact their mortgage decision, and how it might impact their long-term view of housing.

Price Discovery

We are all constantly doing price discovery. What does a gallon of gas cost at the corner station? How much is that favorite bottle of wine? How much is a new pair of jeans, or my Value Meal at McDonalds? We may not be purchasing a load of 2x4’s every week, but we watch the price of our Dunkin’ Donuts’ coffee go up and down. Inflation, usually measured by the price of a basket of goods and services, is an economic term that refers to a general rise in the price of goods and services in an economy. A rise in prices causes the dollar to lose purchasing power. That cup of coffee that is $2.00 today and $2.10 in a year is a 5 percent increase.

The inflation rate is a proxy for understanding how much the average household’s cost of living rises per year by quantifying how much more it costs to buy everyday goods, such as gas, groceries, toilet paper, toothpaste, and other common consumer goods costs relative to how much they cost in the past. Returning to the coffee example above, if coffee was up 5 percent but your client’s salary has gone up 6 percent, well, that is not a big deal. If your client’s salary went up 4 percent, that’s a potential problem.

Saved

As the pandemic rolled along in 2020, the uncertainty or hardship caused consumers to hunker down. Given the prospect of an economic recession, consumers don’t spend like they usually do and instead opt to save. We saw that in 2020 as the savings rate moved above 20 percent, nearly unheard of. (In a “typical” year it tends to hover around 3-4 percent.) Consumers expected a potential loss in consumption-ability, like losing a job or falling real wages, so stopped spending and began savings.

That is a double-edged sword, as MLOs have seen. Sure, it adds to the coffers of potential home buyers, increasing their down payments. But if consumers aren’t spending, business production declines, employees are laid off, and people make fewer investments, possibly creating a downward spiral for an economy. 

That is where the U.S. Federal Reserve and central banks around the world (Bank of England, Bank of Japan, etc.) often try to counteract the withdrawal of consumers by increasing the money supply to stimulate consumption and investment. By banks pumping more money into the economy and reinvigorating it, consumers will have the confidence to spend more in businesses that, in turn, can invest in new or existing products and services.

So, inflation is good, right? No, but your clients should know that sometimes it can be. First, keep in mind that money can enter circulation without causing inflation, and that increased investment can do things like enabling technical innovations that are generally deflationary since goods and services are produced at a lower cost and are more efficient. Your clients may use “new” money to save or pay down debt. Money can be used to hire new workers, give bonuses, or raises to existing employees, and make their company more stable.

Home Thinking

MLOs should also be able to talk to clients about the impact of inflation on their homes. Economists have seen time and time again that “normal” levels of inflation (thought to be 2-3 percent per year) increase in value of scarce asset holdings such as real estate. Put another way, if someone is holding on to cash, earning .25 percent on their bank account, and that cup of coffee is going up 5 percent, that is not a good situation. High inflation is a good thing for debtors because the money they pay back gradually becomes less valuable. If Mr. & Mrs. Nguyen borrowed $300,000 from the bank with a 3 percent annual interest rate and suddenly the economy experiences 10 percent inflation, the Nguyen’s would see their debts at a 7 percent discount in terms of purchasing power. 

So, inflation effectively rewards borrowing, whether it is an individual, a company, or a government. But it disincentivizes lending. When inflation expectations are high, assuming no central bank intervention, nominal rates will rise to offset the long-term decline in currency value for lenders. Most central banks, including our Federal Reserve, closely monitor the inflation rate and set an annual inflation target of roughly 2–3 percent, which they believe promotes a certain level of spending while stimulating sustainable economic growth.

Hedging Their Bets

Meanwhile, your clients should be made to understand that investing in real estate is a popular inflation hedge because property values tend to increase. (Inflation aside, we’re seeing the results of demographics as millions of people in their 20s and 30s have entered the home buying age, bidding up the limited supply of homes.) An increase in property values is due to input costs, like lumber, concrete, nails, going up. Builders demand higher home prices to offset borrowing costs. All of this creates a cycle that is a boost for property owners.

Is a lot of inflation good? No. And one wonders if the constant talk of it in the mainstream press is warranted. The Federal Reserve has done a fine job in keeping the economy stable despite the pandemic, and along with it, inflation has been relatively tame. MLOs should be able to explain inflation to clients, why it can be a very good thing for homeowners, and how the economic stability has helped them. Let’s hope it continues.

This article was originally published in the Mortgage Banker August 2021 issue.
Rob Chrisman
Rob Chrisman

Rob Chrisman began his career in mortgage banking – primarily capital markets – 35 years ago. He is on the board of directors of Inheritance Funding Corporation, of Doorway Home Loans, of AXIS Appraisal Management, and of the California MBA. He is also a member of the Secure Settlements Advisory Board, an associate of the STRATMOR Group, and of the Mortgage Bankers Association of the Carolinas and its membership committee.

Published on
Sep 08, 2021
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