Mortgage rates are running at a 22-year high, further straining the housing market from already high prices.
Freddie Mac reported on Aug. 24 that home buyers face an average rate of 7.23 percent on a 30-year fixed-rate mortgage, the most popular home loan in the United States. This was the highest rate since June 2001.
The rise in rates has cooled the demand for homes, with sales of existing homes falling sharply over the past year. And sellers who locked in low rates during the pandemic are reluctant to put their homes on the market because they fear they won’t be able to get comparable rates when buyers turn up.
Mortgage rates are affected by many factors, most of which are beyond our control. The biggest driver is the bond market, but there’s a lot more to it than that, said Melissa Cohn, regional vice president at real estate lender William Revis Mortgage.
“Most consumers see the simple story, but there are other forces at work,” he said. “Our economy is far more complex.”
What is the effect on mortgage rates?
It starts with the bond market.
Mortgage rates, like many other long-term loans, track the rate, or yield, on the 10-year Treasury bond, which is seen as the safest bet for lenders because it is backed by the US government. For many types of loans, lenders effectively start at that rate, which is often referred to as the risk-free rate, to reflect the greater risk of nonpayment by borrowers such as home buyers. Let’s increase it.
The yield on the 10-year Treasury note recently climbed to 4.3 percent, its highest point since 2007, reflecting the Federal Reserve’s efforts to reduce inflation by raising borrowing costs. The Fed sets short-term interest rates, and expectations of where they will go have a big impact on long-term bond yields.
When inflation is at high levels, the Fed raises those short-term rates to slow the economy and ease pressure on prices. But higher interest rates make it more expensive for banks to borrow, so they raise their rates on consumer loans, including mortgages, to compensate. This has been going on for over a year, with the Fed climbing rates from near zero to above 5 percent, and mortgage rates following suit.
A strong economy affects mortgage rates in other ways as well. A strong job market gives families more money to spend, which increases the demand for mortgages, which drives rates higher.
Lenders also often pool their mortgages into a portfolio, which they use to raise money by selling them to investors. These mortgage-backed securities are similar to bonds.
To remain competitive with 10-year Treasury bonds, lenders need to raise the yields on their mortgage-backed securities, which means higher rates for home loans. The difference between the yield on the 10-year Treasury note and mortgage-backed securities, known as the spread, is typically around two percentage points.
Right now, the difference is more than three percentage points, which has a big impact on the housing market by pushing mortgage rates higher, said Lawrence Yoon, chief economist for the National Association of Realtors.
“It’s really surprising that the spread has been so widespread and persistent,” he said.
How long will rates stay high?
Economists expect mortgage rates to remain high for at least a few more months. And even when they start coming down, they are expected to remain well above the 3 per cent rates that home buyers enjoyed during the initial stages of the pandemic.
Mr. Yoon said he expected rates to begin declining by the end of the year, possibly falling to 6 percent by the spring. “Rationality and economic logic say rates should go lower,” he said, pointing out that the Fed has already slowed its interest rate hikes.
The Mortgage Bankers Association, an industry group, recently forecast that the average 30-year mortgage rate will fall to 5 percent by the fourth quarter of next year.
Fed officials have acknowledged they have to take into account the potential economic costs of raising rates, and Mr Yoon said that includes damage to regional banks such as the collapse of Silicon Valley Bank and Signature Bank.
What can a buyer do to get a lower rate?
It may seem like home buyers have little leeway, but there are things they can do to secure lower rates, said Ms. Cohn of William Revis Mortgage.
A strong credit score is important, he said, as well as a sizable down payment, usually at least 20 percent of the purchase price. Buyers who can manage this may find they are in a less competitive market, which may make it easier to close a deal.
“Rates should come down over the next 12 to 24 months,” Ms. Cohn said, “and home buyers can refinance their mortgages when rates fall.”
She also advises consumers to compare rates from multiple lenders. “There are no magic tricks,” he said. “You need to shop around.”