How does inflation affect mortgage rates? The August CPI notches a gain, but another factor looms larger

Many factors influence the interest rate you get on a mortgage loan, including your credit history, income, the amount you borrow, and the size of your down payment. Average loan rates across the country also play a role — and those tend to rise and fall with inflation. Even the most well-qualified borrowers could receive a higher interest rate during periods of high inflation.

To be clear: Inflation doesn’t directly impact mortgage interest rates, but the two are related. Understanding how inflation affects mortgage rates can help you make the best borrowing decisions. The August Consumer Price Index (CPI), a key measure of inflation, showed that prices rose incrementally higher than expected. However, another economic factor is also in play. How will all of this affect home loan rates?

Learn more: How are mortgage rates determined?

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Before understanding how inflation affects mortgage rates, it’s first essential to know what inflation is and how it’s measured. At its most basic, inflation is the general rise in goods and services costs over time. In short: It’s the reason your grandparents could purchase a home for just $20,000 in the 1960s (that same amount now translates to over $200,000 in 2025 dollars.)

In the U.S., inflation is measured by two different economic indexes: the Consumer Price Index, or CPI, and the Personal Consumption Expenditures price index, or PCE. The Bureau of Labor Statistics uses the CPI to measure the price changes that everyday Americans face. The Federal Reserve primarily uses the PCE to determine policy strategy, as it measures the change in pricing on all items consumed within a given period — not just the out-of-pocket consumer expenses.

Mortgage rates are always in flux, but the average rate on 30-year mortgage loans in Q2 2025 was 6.79%, according to data from Freddie Mac. That’s down slightly from the Q1 2025 average of 6.83%.

These rate fluctuations are partially tied to inflation and the policy changes the Federal Reserve makes in response to monthly inflation readings. We’ll discuss these policy changes and their impacts below.

Learn more: Mortgage rates history — See how rates have changed over time

Since its founding in 1913 via an act of Congress, the Federal Reserve has been tasked with maintaining economic stability in the United States, specifically regarding inflation. That’s because too much or too little inflation can cause economic distress.

On the other hand, consumers don’t spend as much money when inflation is low or stagnant, not even when prices are lowered to tempt more people to make purchases. Low inflation can be a sign of tough economic issues, meaning people might be out of a job or facing other financial problems that keep them from buying goods.

Both high and low inflation can be bad for the American economy and the general consumer. The Fed works to keep inflation at a healthy rate of approximately 2%, most notably by setting the federal funds rate, which is the interest rate that banks charge when they lend to other banks.

Banking institutions must manage large sums of money daily. To do so, sometimes they borrow cash from another bank through the Federal Reserve System.

These loans are made overnight so the borrowing bank can meet its liquidity needs the next morning. And just like a consumer loan, the borrowing bank has to pay interest on the loan to the lending bank.

The benchmark interest rate banks charge each other for these overnight loans is called the federal funds rate. When lending to consumers, on the other hand, banks offer interest rates based on the federal funds rate plus an additional margin to ensure they make a profit. That’s why interest on mortgages and other consumer loans is typically higher than the federal funds rate.

Inflation and the federal funds rate

The Federal Reserve adjusts the federal funds rate to help shape the country’s economy. When inflation is high, the Federal Reserve might increase the federal funds rate in an effort to slow down inflation. The thought is that fewer people will borrow money when rates are higher, which can help reduce the influx of cash into the economy and thereby stabilize inflation.

According to the August CPI, prices increased by 0.4%, after rising 0.2% in July. Economists were looking for a slightly cooler 0.3% gain.

The year-over-year CPI for the 12 months ending in August increased by 2.9%, in line with expectations.

However, it was a surge in initial jobless claims that raised expectations of a Fed cut to short-term interest rates at its meeting next week. New claims for unemployment benefits rose to 263,000 through Sept. 6, the highest since October 2021.

According to the CME FedWatch tool, it’s a virtual lock that the Fed will lower its rate — now the question is, will it be a quarter-point or a half-point decrease?

Dig deeper: How the Federal Reserve impacts mortgage rates

The Federal Reserve must adjust the federal funds rate in response to economic changes, so it’s impossible to predict when mortgage rates will go down (especially in the long term) since we cannot know future inflation rates. For example, the market downturn that accompanied the onset of the COVID-19 pandemic had a major impact on the American economy — and mortgage rates — and it was impossible to predict.

However, even though we can’t know what future inflation will be, the Federal Reserve does create a regular inflation report to forecast where the economy will go over the coming year and decade. Though this report obviously can’t guarantee the future, it does use known parameters to set expectations for future inflation. As of August 2025 — the most recent inflation data at the time of writing — the Fed forecast 3.2% inflation for the coming year. This is based on various factors, including the CPI and PCE.

Inflation forecasts spiked in March, April, and May, then decreased to 3% in June. Now, the number has inched back up to 3.2%.

Read more: How to get the lowest mortgage rate possible

Inflation can certainly impact mortgage rates, but it impacts home buyers in other ways, too. For one, it can send housing prices upward. As the prices of goods and services rise, so do the costs of material and labor to build and sell homes — which means higher home prices for consumers.

Buyers may also face higher prices on various closing costs and third-party services surrounding their purchases, like inspections, appraisals, moving costs, and more, as these can also rise due to inflation.

There is a benefit, though: Inflation — and the higher prices that come with it — could reduce demand for homes and make the housing market less competitive. This could make it easier to snag the house you like without getting into a bidding war or haggling with the seller.

Dive deeper: Which is more important, your house price or interest rate?

Inflation reports such as the Consumer Price Index and Personal Consumption Expenditures price index reports will not directly affect mortgage lenders’ interest rates. However, what those reports indicate for the future — and the Federal Reserve’s response to those expectations — will. Generally speaking, as inflation rises, so do interest rates, including those on mortgages.

When inflation rates rise, the Federal Reserve generally increases the federal funds rate, which leads to higher interest rates on consumer borrowing products too. By increasing interest rates during periods of inflation, the Fed helps to slow down consumer spending and get inflation under control.

It is impossible to know for certain where mortgage rates will go in the future since unforeseen events that affect the economy (like COVID-19) cannot be predicted. Based on Fannie Mae’s August Housing Forecast, though, mortgage rates are expected to be basically flat over the next few months, with the average 30-year rate sitting near 6.5% by year’s end. The 2026 forecast is for rates to edge down to 6.1%.

Homeowners usually benefit from inflation, as home prices tend to rise when inflation does. That means they gain more equity and can potentially earn more profit from their homes when it’s time to sell. Home buyers, on the other hand, do not benefit. They typically face higher mortgage rates and higher home prices when inflation increases.

This article was edited by Laura Grace Tarpley.