Where Mortgage Loan Interest Rates Are Headed
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UPDATED: Jul 9, 2012
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Since the beginning of May, the 30-year fixed mortgage interest rate has been occupying printed and virtual news headlines across the country. Writers and editors are running out of synonyms for the phrase “breaking historic records,” as week after week, Freddie Mac’s mortgage loan survey reveals the 30-year rate shattering the record floor. These recent trends seen in the 30-year fixed mortgage loan rate is prompting consumers everywhere to at least entertain the idea of homeownership. And for those who have been teetering on the edge, these sub-4 percent rates might just be the extra push they need.
But amidst these optimistic reports, two questions immediately emerge: is now finally the time to buy? And are these historic interest rates going to fall any lower?
Is Now the Time to Buy?
Since the housing market collapse of 2008, this question has been asked by wise investors and laymen alike. From the beginning, there were experts on either side—some vehemently screaming, “Yes,” while others gave an ominous and strong, “No.”
While 2008 to 2011 have obviously proven not to be “rock bottom,” 2012 is looking pretty promising.
The housing market peaked in 2006, where, according to a Wall Street Journal interview with Eric Lascelles, a chief economist with RBC Global Asset Management, real estate prices were 34 percent higher than what they are today.
Couple that more-than-one-third of a discount with never-before-seen mortgage loan interest rates, and very few would disagree that now’s a wonderful time to buy a home. Prices may continue to drop, and rates may continue to sink lower, but for those considering whether or not now is the time to buy, the best answer anyone can give is, “now is definitely not a bad time to buy.”
Should I Wait Until Rates Go Lower Though?
Unfortunately the answer to the rates question isn’t nearly as obvious. Given the fact that out of the last 11 weeks, 10 have produced interest rates that the country has never before seen, only somebody with future-seeing capabilities would be able to accurately tell where interest rates are heading.
But what we can do is make an educated guess as to where mortgage loan rates are going by looking at past trends.
Using Freddie Mac’s mortgage market databases, we aggregated the following information:
This graph shows a wide range of years and the mortgage interest rate trends associated with them.
That bottommost line is where we’re at now. If we were to look at the flow of interest rates in the boom-time years (2006 to Dec. 2008), we would see that there’s a natural tendency for rates to drop come mid-summer and bounce back up in the beginning of the following year.
But after the end of 2008, when the crash occurred, we start to see a different rate progression trend: one that primarily shoots downward.
If we just used the trends from the last two years (the years that most closely resemble our current trajectory) to make our hypothesis, then we would likely conclude that our home loan rates will continue to fall until the end of the year.
However, we need to bring into account another important factor: the federal funds rate.
Our Banks’ Interest Rate
Banks don’t borrow money at the same rates we do. Instead, they receive a heavily discounted rate from the government. The rate at which banks borrow money is called the federal funds rate.
Federal funds rates are controlled by the Federal Open Market Committee (FOMC), which is composed of the seven members from the Federal Reserve Board and five Federal Reserve Bank presidents. Eight times a year the FOMC meets, and during those meetings they determine what the federal funds rate will be.
They steer that rate higher or lower depending on what the economy needs to stimulate healthy spending and to curb inflation.
This rate is important to pay attention to because if it’s higher, banks pay more to borrow money. If banks pay more to borrow money, then—typically speaking—the public will see higher interest rates on their mortgage loans.
Using the historical data preserved on the Federal Reserve Bank of New York’s website, here’s a trajectory of the federal funds rate from 2006 to the present day:
Pay special attention to when federal funds rates fell, and where they have remained for the past four years. Right as the housing market began to shake with pent up pressure, the FOMC dropped the rate, trying their hardest to stop the inevitable onslaught they saw coming on the horizon. Then, in December 2008, the federal funds rate nosedived into oblivion.
Now if we combine all of the multi-colored lines from the 30-year mortgage loan rates graph depicted above, and stretch those out to be overlaid on the federal funds rate, we start to get a picture of exactly how the federal funds rate influences our everyday mortgage loan interest rates.
With few exceptions, when the federal funds rate declines, so too do our mortgage loan rates. The exceptions most likely occur because of decisions made by the FOMC or individual banks trying to stabilize the financial crisis, but generally speaking, these two rates do travel on parallel roads.
As Brett Sinnott, director of secondary marketing at CMG Mortgage Group told Bankrate.com, “If it is more expensive for banks to borrow, they will pass that expense on to their customers.”
The Answer’s in the Gap
So where does that leave the formulation of our hypothesis?
The answer is in the gap between the federal funds and the 30-year mortgage loan rates. Look back at 2006 and 2007; the red and blue lines were awfully close to one another. This means that banks have little to no problem lending at levels close to what they receive money for. They don’t necessarily need to make 5-plus percent on a home loan. As proven by the past, they’re content with making just over 1 percent on the money they lend.
But right now, we’re seeing banks are making near 5 percent on each home loan they originate.
This tells us that mortgage loan rates have the potential to continue their downward trajectory—but that doesn’t mean they necessarily will.
If the FOMC increases the federal rate to curb this unprecedented downward spiral of historical low interest rates we’ve been seeing, expect mortgage loan averages to reverse their course and start rising again. While Ben Bernanke has said he expects real estate rates to remain low for some time, there’s no certainty until the passing of each FOMC meeting. The FOMC’s next meeting is scheduled for the very end of July.
Let’s then hypothesize that 30-year mortgage loan interest rates will be closely related to the FOMC’s future decisions regarding the federal funds rate.