Gone are the days of sub-3% 30-year fixed mortgage rates.
Heck, even 4% 30-year fixed mortgage rates are a thing of the past, despite being available as recently as February.
Today, you might even be hard pressed to obtain a rate in the low-5% range, depending on your particular loan scenario.
This hasn’t noticeably slowed down the housing market, though Realtor.com recently listed a top-10 list where home prices are falling.
The bigger concern at the moment is housing affordability and a surge of mortgage layoffs. But why exactly are mortgage rates going up so fast?
Inflation Is One Part of the Story
The government was very accommodative over the past decade to ensure the economy didn’t derail again just a decade after the Great Recession.
In a nutshell, this meant interest rates at zero, at least with regard to the federal funds rate, which is what banks charge one another on an overnight basis.
This basically dictates what these banks then charge consumers for all types of loans, whether it’s a credit card, auto loan, or home loan.
After all, if they can borrow cheap money, they can lend out relatively cheap money too.
But after years of very generous lending terms, the Federal Reserve has begun raising rates to combat inflation, which had loomed for years.
As to why inflation got so bad so fast, it was these years of loose lending combined with the pandemic, which dislocated the global supply chain.
That meant fewer goods and a lot of money chasing those goods, which significantly increased prices.
Imagine 100 people with fat wallets and only 10 bicycles for sale. They all really want them, so the price skyrockets.
With regard to mortgage rates, it’s more complicated because banks need to offer a product that is still profitable in the future with inflation-adjusted dollars.
If the dollar is expected to be worth less in the near future due to inflation, they need to charge a higher rate of interest to make up for that.
The Bigger Driver Might Be the End of Quantitative Easing (QE)
While the Fed kept bank-to-bank lending cheap via the federal funds rate, it wanted to do more to impact consumers directly.
It accomplished this via Quantitative Easing (QE), which involved the purchase of hundreds of billions in long-term Treasuries and mortgage-backed securities (MBS).
In short, the value of these securities went up in price because there was a willing and able buyer called the Fed.
As the price of these bonds went up, the associated interest rate (yield) fell, which led to record low mortgage rates for consumers.
Unfortunately, the Fed couldn’t keep this up forever as it was beginning to lead to major inflation concerns. Too much cheap money leads to higher prices.
They actually “tapered” these purchases back in 2013 as the economy seemed to be getting back on track.
By taper, I mean reduced purchases, as opposed to selling off what they had. This caused the 30-year fixed to rise from around 3.5% to 4.5% in the span of six months.
Here’s why mortgage rates are going up so fast right now; the Fed announced Quantitative Tightening (QT), which is a huge step up from tapering.
It’s the actual sale/runoff of all these bonds and mortgage-backed securities. In other words, not only are they not buying more, they ditching the ones they own.
As such, banks and mortgage lenders can’t keep doling out ultra-cheap mortgages. Why? Because the Fed ain’t buying the underlying mortgages anymore.
Investor demand for home loans has essentially plummeted.
Will Mortgage Rates Go Back Down?
Imagine if you always had a buyer for the products you offered that was willing to pay a huge premium. And they couldn’t get enough of what you sold.
Now imagine that buyer tells you one day that they’re out of the business for good. And to boot, they’re selling their entire supply!
This is what has happened to mortgage lenders seemingly overnight. Most lenders don’t keep the home loans they originate. They sell them and/or package them as securities.
When demand is strong, they can offer low interest rates. When supply is high, they can’t.
These mortgage lenders now have to be a lot more cost-conscious. Simply put, this means charging much higher mortgage rates to their customers.
This explains why your 30-year fixed mortgage rate is no longer 2.75%, but instead closer to 6%!
Because lenders and their investors now have to turn to the open market to sell the mortgages and underlying bonds.
And the prices are a lot lower than what the Fed was willing to pay. They make less, you pay more, end of story.
We can basically kiss the record low mortgage rates goodbye. That is, unless the Fed brings back QE again in the future, which seems unlikely.
The other piece of the puzzle is inflation. If it turns out to be transitory in nature, aka short-lived, mortgage rates could improve, perhaps as soon as late 2022.
We’re basically in a worst-case environment right now where no one wants to offer low rates and get burned.
But as the inflation picture becomes clearer, mortgage rates could go down.
Will they return to 3% again? Highly doubtful. However, they could fall back into the mid-4% range if it turns out we overshot the mark.
This could mean better mortgage rates in the second half of 2022 and early 2023. But it’s going to take a while for mortgage lenders to feel comfortable lowering rates by any meaningful amount.
(photo: Steve Jurvetson)