First the bad news. According to the latest data from the Mortgage Bankers Association (MBA), the current average 30-year fixed mortgage rates are 2.5% to 3% higher than a year ago. Current 30-year mortgage rates range from 5% to 6% for most borrowers (depending on the borrower’s credit score and the type of transaction).
What most people don’t realize is that current mortgage interest rates are still low compared to mortgage interest rates in the 1970’s, 1980’s, 1990’s and 2000 through 2007. During these periods mortgage interest rates reached as high was 18% and were generally above 6%.
FUTURE MORTGAGE INTEREST RATE ENVIRONMENT
Due to inflation, the Federal Reserve has been tightening since January 2022 by reducing its asset holdings and by increasing the interest rate that it controls, the Federal Funds Rate. The Federal Funds Rate does not directly impact mortgage interest rates (more on this later), however the change in the policy of the Federal Reserve in January 2022 does impact mortgage interest rates indirectly because a change in Federal Reserve policy impacts all types of interest rates.
As we begin August 2022, the outlook for mortgage interest rates remains uncertain. However, there is a growing belief that sometime in the second half of 2022 or in early 2023 mortgage interest rates will decline. During the final two weeks of July mortgage interest rates have moderated and have declined slightly and more importantly volatility in mortgage interest rates has decreased. There is optimism that mortgage interest rates may have peaked due to the belief that the U.S. economy either has already entered a recession or will enter a recession in the second half of 2022.
If the employment picture begins to deteriorate it is likely that the Federal Reserve will be forced to modify/change policy in order to avoid a long-lasting recession. A potential change in policy will lead to a change in future interest rate expectations for all types of interest rates and will lead to lower mortgage interest rates.
BACKGROUND ON MORTGAGE INTEREST RATES
Who sets mortgage rates? Why do rates change? How often do rates change? These are some of the questions that are often asked. Like a lot of things in life, many people believe one thing when in fact something totally different is true.
When it comes to mortgage interest rates the public believes that the Federal Reserve, Congress, the Government, banks or some other entity or person sets mortgage interest rates. While the actions of each of the parties mentioned can influence mortgage interest rates, none of these parties or entities “sets” mortgage interest rates.
The real answer is that mortgage interest rates, and the corresponding fees or points charged for various rates, are set by the prices of Mortgage Backed Securities (MBS). MBS are pools, or groups, of mortgages packaged into securities for sale in the secondary market. These MBS are traded in a manner very similar to stocks and are sold to investors. What investors pay a pool of MBS is what sets interest rates. In other words, investors who invest in mortgages set mortgage interest rates
Wholesale and correspondent lenders purchase loans from brokers and banks that originate mortgages for homeowners, with the intent to resell those loans by packaging them into MBS and then selling to investors into the secondary market. The going price in the secondary market for mortgages at various interest rates influences the rates and prices a broker or bank will offer to the public. The value of the mortgages and the price of MBS is constantly changing which is directly the reason mortgage interest rates offered to the public change daily.
The two factors that impact mortgage interest rates the most, and what investors are willing to pay for MBS pools, are economic growth and inflation. The faster the economy is growing, the more demand there will be for capital, leading to a higher cost for borrowing money. That is why good news about the economy is often good for stocks but is bad for mortgage interest rates. In addition, growing economic activity adds to demand for all types of resources which leads to inflation. Inflation erodes the value of a dollar, so a lender will demand more dollars back later to compensate for the lost purchasing power.
Since mortgage rates are often fixed for the life of the loan, inflation over the years can seriously diminish an investment’s inflation adjusted return. At the time an investor purchases a MBS, the rate of inflation will be over the life of the loan must be predicted. As a result, the investor will demand that the yield on the investment exceed the expected rate of inflation by enough to earn a reasonable return. Predicting what inflation will be for years in the future can be very difficult and being wrong can be very costly. This is why MBS prices are highly sensitive to anything that changes investors expectation of future inflation.
Any news which provides information about the current level and expected level of economic growth or inflation will influence prices. Economic reports and data that measure the strength of the economy and the amount of inflation are released on a weekly basis. Some data and reports have more significance than others.
This is a brief explanation to answer the question of who sets mortgage interest rates, and outlines some of the factors that that cause mortgage interest rates to change on a daily basis.
The simple answer is that the Federal Reserve Bank (the “FED”) continues to modify and adjust its policy.
The reason for the change in FED policy was that the inflation that began in 2021, which originally was ignored and downplayed by the FED, has exploded in 2022. The causes of current inflation include but are not limited to economic data in the US, massive government spending in 2020 and 2021, the ongoing pandemic that affected the price of other goods due to supply chain disruption, the increase in energy cost as a result of policy changes and made worse by the war in Ukraine that has affected the price of all commodities (oil, gas, copper, industrial materials, etc.…). Controlling Inflation is one of the two primary policy goals of the FED and to this point its policies have failed to control inflation.
The expectation by the financial markets is for inflation to continue to grow which caused interest rates to rise in anticipation of future FED actions, including their state objective to increase the FED Funds Rate and to substantially reduce the purchases of Mortgage-Backed Securities. It is noteworthy to note that during the first quarter of 2022, the FED has confirmed that the market is right to be afraid of its change in policy.
This sums up the big problem for mortgage interest rates so far in 2022 and the reason for the unprecedented increase in mortgage rates at the fastest pace, in a similar time frame, since 1994.
For the week ending March 31, 2022, the average 30-year fixed mortgage interest rate, published by Freddie Mac, rose to 4.67% nationwide. This rate was approximately 3% on January 1, 2022. This is the highest level for interest rates since December 2018 and the sharpest increase in mortgage interest rates in such a short timeframe since 1994.
BACKGROUND ON FED POLICY
Fed policy involves setting the key overnight lending rate in the US (the Fed Funds Rate) as well as deciding when to buy and sell large amounts of various types of bonds.
The types of bonds purchased by the FED include US Treasuries and Mortgage-Backed-Securities (MBS). The MBS market directly influences mortgage rates. As a result, the Fed policy for purchasing MBS bonds has a direct and significant impact on mortgage rates. If the Fed gives the market a reason to expect smaller MBS purchases, mortgage rates will rise.
Starting in November 2021, the Fed began reducing the size of its bond purchases that began at the start of the pandemic. This was bound to happen at some point, but November was a bit earlier than financial market experts had expected. As a result, MBS suffered, and mortgage interest rates began to rise. 30-year mortgage rates were as low as 2.5% in the fall of 2021, prior to this announcement.
In December 2021, the Fed announced it would decrease MBS purchases at a faster pace than previously announced in November. At the beginning of January 2022 mortgage interest rates had risen to just above 3% following the December announcement.
On January 5th, 2022, the minutes from the December’s Fed meeting were published. The minutes are closely reviewed because they often reveal additional details that didn’t make it into the official policy statement released immediately following the meeting (generally three weeks earlier). When the minutes were released, it was learned that the Fed was discussing decreasing the purchase of MBS bonds at a faster pace than previously announced. More concerning was that the FED had also been discussing a faster pace of rate hikes for the Fed Funds Rate. While the Fed Funds Rate does not directly govern mortgage rates, if the market suddenly expects more/faster increases of the Fed Funds Rates, all types of interest rates will increase at a faster pace, including mortgage rates.
Following the January 5 meeting there was an immediate shift in rate hike expectations. With the Fed Funds Rate in the 0.25-0.50 bracket at the beginning of November 2021, it will require EIGHT rate hikes in the standard 0.25% amount to hit the current 2022 year-end target of 2.5% to 2.75%. There are only 6 Fed meetings remaining! So at least 2 of those meetings will require a 0.50% hike. It has been more than 20 years since the FED has increased the FED Funds Rate 0.50% following a meeting.
This rapid repricing of expectations is the cause of volatility in interest rates right now. The decrease in MBS purchases by the FED is also a large factor in the increase in mortgage interest rates in 2022.
There is hope on the horizon. The higher rates go and the faster they get there, the sooner we will see a stable and predictable interest rate environment return. This can happen even as the Fed continues to hike rates because the mortgage and Treasury markets anticipate interest rate changes based on future expectations and move in advance of the FED announcing any actions. When the future plays out as expected, rates generally do not continue to increase and often will decline.
Any additional surprises will depend on incoming data and events–especially inflation related data and geopolitical events that greatly affect the outlook for growth or inflation.
Many mortgage professionals and consumers have become complacent about mortgage interest rates given the low levels they reached and maintained in the second half of 2020, even though other indicators said rates should be rising.
Mortgage rates generally follow the 10-year Treasury rates closely and late last year and early in 2021 the benchmark 10-year Treasuries have spiked up off the lows of early 2020. Mortgage rates are somewhat higher than at the end of 2020 and they have become much more volatile as we begin 2021. What that means is that they have been moving in a wider range up and down, daily. Although, at the time of this writing, are only slightly higher than the lows we saw in 2020.
COVID and its impacts on the economy remain the leading forces driving the economy and the bond markets but as a vaccine rolls out and COVID restrictions are relaxed, mortgage rates are likely to rise. Additionally, following the Senate races in Georgia in early January, we saw one of the sharpest interest rate spikes of the past few years. Although mortgage rates have fallen back to pre-January 5th levels, the 10-year Treasury rates have continued to rise.
As we move further into 2021 it is likely that mortgage interest rates will begin to rise moderately from the lows of 2020 and follow the 10-year Treasuries higher, barring anything unexpected. For those looking to purchase or refinance in 2021, the first half of the year may be better as far as capturing today’s low mortgage rates.
One note to be aware of is that for the most part, interest rates that are reported in the press are reporting the prior week’s activity. Often the headlines and stories are based on information that is old. Mortgage rates could be substantially different in the current week from what the headlines reflect.
In 2018 mortgage interest rates were on a roller coaster. The year started with anticipation of 2 rate increases by the Federal Reserve and with mortgage interest rates at approximately 4.5% for a 30-year fixed rate. There were 4 rate increases, which led to great controversy by the end of the year. Beginning in April and through the summer mortgage rates rose at their fastest pace in years and topped out at 5.125% in September. However, against the headwinds, September mortgage rates have steadily fallen and ended the year at their lowest level since the start of the year and at the beginning of 2019 are in the 4.7% range for a 30-year fixed rate mortgage.
In fact, despite steady climbing for the past two years, mortgage rates remain lower than they were during most of the recession and below average for the type of strong economic growth we’ve been experiencing.
As we enter 2019, the following housing agencies are forecasting the following rate for 2019.
|Agency||30-Yr Rate 2019 Prediction|
|National Association of Realtors||5.3%|
|National Association of Home Builders||5.2%|
|Mortgage Bankers Association||5.1%|
|Average of all agencies||5.17%|
These forecasts are largely based on the Federal Reserve’s current outlook for economic growth, inflation and unemployment. The Federal Reserve currently has set expectations for 2 rate increases in 2019. However, they have hedged following the December meeting by stating that future rate increases would be dependent upon the data.
THE CASE FOR FLAT RATES OR POSSIBLE A DECREASE IN RATES
While the majority view is that mortgage rates will rise from one-half percent to one percent in 2019, there are a couple of scenarios that would slow down the increase or even lead to lower mortgage interest rates. According to the Federal Reserve projection, U.S. GDP growth will slow to 2.3 percent in 2019 from 3 percent in 2018. The unemployment rate ended at 3.7 percent in 2018 and is expected to fall to 3.5 percent in 2019. Inflation was forecast to be 1.9 percent in 2018 and 2019.
However, many economists believe the economy is showing some weakness that has not been fully reflected in the data. And while there are few economists or analysts that are forecasting a recession in 2019, if economic growth falls below 2% then future rate increases would likely be paused. Similarly, inflation has softened in recent months, and falling oil prices probably reduces the Fed’s sense of urgency about raising rates to prevent the economy from overheating.
If GDP growth or inflation comes in below targets or if unemployment rises it would likely pause Fed activity with regard to rate increases and under the right set of circumstances could lead to a decrease in rates. In either of these cases, mortgage interest rates would likely fall from the levels they were.
IMPACT OF RISING RATES
Home prices have surged in recent years, adding to buyers’ affordability woes. Although prices are still projected to go up in the year ahead, they’ll do so at a slower pace. Median existing-home price appreciation is expected to grow 2.2 percent in 2019, according to Realtor.com. Freddie Mac predicts that home prices will finish 2018 up 5.1 percent over last year. Growth will moderate to 4.3 percent in 2019.
Real estate is local, so your area may see prices move higher or lower depending on demand and inventory levels.
The combination of rising mortgage rates and higher prices mean home buyers are spending more. The root cause of the increased spending is the impact of inflation in the form of surging wage growth, which is the main cause of higher interest rates. According to the Bureau of Labor Statistics, wage growth has reached its highest level since 2000. In the big picture, rates are just catching up with a robust economy and there is no indication that the real estate market will falter any time soon.
To put this point in perspective according the Bureau of Labor Statistics, Consumer House-Buying Power Remains 2.2 times greater than January 2000.
Another factor that mitigates the affordability issue is the fact that rents are expected to begin rising again in 2019 due to demand from more renters.
As has been the case for the past two years the prudent course of action if you are going to be in the mortgage markets is that the sooner you act you can avoid the volatility associated with the factors that impact mortgage rates.
When looking at any interest rate forecast it is often helpful to look back first to see where things have been. First, for some historical perspective on interest rates:
Decade Lowest Rate Highest Rate
1970’s 7.23% (1972) 12.90% (1979)
1980’s 9.03% (1997) 18.63% (1981)
1990’s 6.49% (1998) 10.67% (1990)
2000’s 4.71% (2009) 8.64% (2000)
2010’s 3.31% (2012) 5.21% (2010)
More recently, during 2017 interest rates for a 30-year fixed rate mortgage peaked in Mid-March at 4.44%. By the end of 2017, mortgage interest rates on the same 30-year fixed rate mortgage had fallen to 4.15%. Mortgage interest rates ended 2017 lower than what many had projected.
As always, at the beginning of 2018 there were lots of predictions regarding what would happen with interest rates in 2018. The one common denominator in all the projections was the expectation that mortgage interest rates would rise in 2018. 100% guaranteed. Here were a couple of the predictions from a couple of the largest housing and mortgage groups for the 30-year fixed-rate mortgage:
Where we are now?
As we sit at the mid-point of the year, mortgage interest rates have risen at a faster pace and to a higher level than most predicted at the beginning of the year. According to loan software company Ellie Mae, which processes more than 3 million loans per year, here is data on interest rates for May 2018:
Where are we headed?
As we head into the second half of the year we know a few things. The Federal Reserve intends to continue raising short term interest rates since unemployment is low and is expected to go lower. Also, inflation is close to their objective. The Federal Reserve does not want the U.S. economy to get too hot too fast since overheated growth can lead to inflation and difficulties for the economy. The next rate hikes are expected to happen in September and December.
Additionally, the economy continues to perform well and put upward pressure on rates. Mortgage rates tend to be higher when the economy is doing well. This is because inflation takes off and investors seek higher returns than mortgage bonds can offer. In response, mortgage interest rates must rise to keep investors interested in them at all.
For the most part the news is good. The economy is performing well, people have jobs, and they are likely to get a raise. Although they have risen in 2018, mortgage interest rates are well below their historical averages. This is all good news. However, if you’re in the market to buy a home or refinance this year, don’t expect rates to drop. It is likely that mortgage interest rates will rise over the second half of the year and will likely end the year around 5% for a 30-year fixed rate mortgage.