Fed Rate Hike Impact on Mortgage Rates
The following chart from the year 2000 to 2015 compares what the Fed directly controls, which is the short-term federal funds rate, to the long-term 30-year fixed mortgage rate. There appears to be some influence in direction between the two rates but certainly not a large one. There is also movement in mortgage rates on their own, even when there are no changes to the fed funds rate.
One very specific period worth noting is from mid-2004 to mid-2006 when the Federal Reserve hiked the short-term rate from 1.0 percent to 5.3 percent. Over this two-year period the mortgage rate bounced around a narrow band from 5.8 percent to 6.3 percent. That is, more than a four percentage point rate hike by the Fed resulted in only half a percentage point rise in mortgage rates. Why?
Long-term mortgage rates are guided by market forces that include many factors, whereas the Fed’s short term rate is just but one factor. The other influencing factors on mortgage rates are the inflation rate and the erosion of the purchasing power of money, the global reserve currency status, the budget deficit and debt, household savings rate, corporate borrowing enthusiasm, printing of money, the degree to which the government will guarantee mortgages, and a host of others. It all comes down to the supply and demand of mortgage funds against alternative investment choices.
Whether the Fed hikes its rate in September or October is a non-event for the housing market in my view. What we need to know is that, from the current effectively-zero interest rate, the fed funds rate will continue to rise over the next two years such that by the time of the mid-term elections in 2018, the fed fund rate will have reached 2.5 percent or a bit higher. At quarter point increments, that would amount to more than 10 announced changes in interest rates by the Fed that news stations will no doubt play up each time.
The 30-year fixed mortgage rate, which is consumers’ dominant choice for home financing, may hit 4.5 percent by the end of this year and then likely move up further to hit 5.5 to 6.0 percent in two to three years. The upcoming cycle of rate hikes from the Fed looks to have more of an impact on mortgage rates than in the past simply because the mortgage rates are already starting from unimaginable levels. Should inflation surprise on the upside, mortgage rates could be measurably higher. This could come about if the housing shortage persists with homebuilding lagging well behind population growth, which in turn will drive up apartment rents and owner-equivalent rents. These two measures comprise a very large weight of nearly 30 percent in the overall Consumer Price Index. Higher inflation could also lurk should the budget deficit situation deteriorate in the future, and without a credible fiscal plan to sustain financing in other ways than by printing money due to political gridlock, for example.
Assuming homebuilders get more active and the deficit is contained, however, mortgage rate increases will be very manageable. The average mortgage rate was 9 percent in the 1970s, 13 percent in the 1980s, and 8 percent in the 1990s. Therefore, the anticipated mortgage rate rise to 6 percent is not alarming. In addition, there will be compensating factors to rising rates that can enlarge the pool of homebuyers. The underwriting criteria will slowly move away from over-stringency just from the fact that mortgages underwritten during the past five years have had exceptionally low default rates. There is a profit motive for lenders to make more loans. Moreover, rates are rising for good reasons: an improving economy and job additions. Therefore, consumers can absorb slightly higher rates and the housing market should be just fine.
Source: Lawrence Yun, Contributor for Forbes.com, Chief Economist of National Association of REALTORS - http://www.forbes.com/sites/lawrenceyun/2015/08/21/fed-rate-hike-impact-on-mortgage-rates/
Freddie Mac reports the following national averages with mortgage rates for the week ending Aug. 20:
- 30-year fixed-rate mortgages: averaged 3.93 percent, with an average 0.6 point, dropping from last week's 3.94 percent average. Last year at this time, 30-year rates averaged 4.10 percent.
- 15-year fixed-rate mortgages: averaged 3.15 percent, with an average 0.6 point, falling from last week's 3.17 percent average. A year ago, 15-year rates averaged 3.23 percent.
- 5-year hybrid adjustable-rate mortgages: averaged 2.94 percent, with an average 0.5 point, rising from last week's 2.93 percent average. A year ago, 5-year ARMs averaged 2.95 percent.
- 1-year ARMs: averaged 2.62 percent, with an average 0.3 point, holding the same as last week's average. A year ago, 1-year ARMs averaged 2.38 percent.
"Housing markets have responded positively to low mortgage rates," says Sean Becketti, chief economist at Freddie Mac. "The latest NAHB/Wells Fargo Housing Market Index for August 2015 was 61, the highest level in more than nine years. One-unit housing starts in July 2015 jumped to 782,000 units, up 12.8 percent from June and up 19 percent from last year. Overall housing markets remain on track for the best year since 2007."