Question: Many believe the Federal Reserve will raise interest rates in December. Doesn’t that mean we should expect mortgage rates to rise later this year?
Answer: The Federal Reserve has the ability to raise the rates charged by banks, but it does not control the mortgage marketplace.
At first, it might seem as though the interest rates charged by banks and mortgage rates march together, but that’s not the case. The difference is this: Bank rates are influenced by Federal Reserve actions announced in Washington while mortgage rates reflect the supply and demand for money worldwide.
Essentially, we have two baskets of money: one controlled by the Fed and another not controlled by anyone. For better or worse, mortgage money largely comes from the basket which is free of Fed control.
Let’s look at mortgage rates during the past decade or so.
Back in 2008, at the height of the housing crash, the average annual mortgage rate that was 5.04 percent according to Freddie Mac. Also in 2008, the Federal Funds target rate was .25 percent.
Now, skip forward to 2015. In December of that year, the Fed raised the Federal Funds target to .5 percent, an increase of .25 percent. The average annual mortgage rate was 3.85 percent.
In 2016, the Fed again raised the Federal Funds target rate in December by another .25 percent to .75 percent. That same year, the average annual mortgage rate fell to 3.65 percent, near the lowest on record.
This year, the Fed raised the Federal Funds rate by .25 percent in March and by another .25 percent in June. That puts the Federal Funds target rate at 1.25 percent.
If we look at this recent history the pattern is clear. In 2008, mortgage rates were in the five percent range. After four Fed rate increases, mortgage rates fell to 3.94 percent at the end of October. Bank rates went up while mortgages rates have gone down.
With another Fed increase widely predicted for December, should we expect mortgage rates to rise? Or fall some more?
The answer is that no one knows. Has anyone calculated the financial impact of Hurricanes Harvey, Irma, Nate, and Maria? Will there be a political or financial crisis between now and December? Or soon thereafter? We just don’t know.
Because mortgage rates are not set by government officials, they simply move up and down in response to supply and demand. Right now, the supply of capital is overwhelmingly huge while demand is relatively small.
The reason mortgage rates today are around four percent is that cash is like pollen – it’s everywhere. There’s so much money that the United Nations estimated in July that $8.5 trillion is invested worldwide with negative interest rates and another $40 billion is getting by with “very low returns.”
When the Fed raises the Federal Funds rate, it does a favor for banks because they then raise the prime rate and the cost of financing goes up. Alternatively, when financing costs rise, borrowers pay more and this reduces their incentive – and sometimes their ability — to borrow.
Things are different in the mortgage marketplace. Many of the largest players are “nonbanks,” or companies that originate mortgages but don’t have ATMs, tellers, checking accounts, or branches; companies which often use artificial intelligence to move applications quickly through the underwriting process.
Nonbanks cannot borrow from the Fed, but they can borrow from investors worldwide – including those vast money pools which are now getting by with just “very low returns.”
This is a very good situation for home buyers. In a competitive marketplace, lenders must pass through low rates; if they don’t, they’re soon out of business.
Looking toward the coming year, the Mortgage Bankers Association predicts that mortgage rates will reach 4.8 percent by the fourth quarter of 2018. That’s a remarkably-low rate by historic standards, and it surely includes the expectation that the Fed will continue to raise bank rates. The wonder is not that rates are forecast to go up, it’s that they’re predicted to rise so little.
Still – if the MBA is right – rates will rise during the coming year. That means now may be a better time to finance and refinance if you can.