EXPLAINED: What Really Determines Mortgage Interest Rates?
The last couple years have stirred up lots of talk around interest rates. From their historic lows in 2020/2021, to historic increases over the past 6 months. We’ve heard that the Federal Reserve (the central bank of the United States) is increasing rates in an effort to curb inflation, but do you wonder what the Fed has to do with rates? Why they change daily? Why there are different rates from different companies?
Let’s explore…
First, contrary to popular belief, the Federal Reserve doesn’t raise mortgage rates directly. Mortgage rates are actually determined by Mortgage Backed Securities (MBS). These are bonds that are traded just like stocks, and the value moves throughout the day which is why we can see a swing (big or small!) over the course of a day—just like we see with stocks.
With that said, there is a correlation between the two. When there is news from the Fed that either is or isn’t anticipated, it can/will impact mortgage rates.
Recently, we anticipated the Fed would raise its benchmark rate by ¾ of a percentage point. Since this was an expectation and already baked into the plan, mortgage rates didn’t move at the same amount—we expected it. On the other hand, if we anticipate a ¾ percent hike and the Fed instead raises their benchmark rate by a full point, mortgage rates would definitely go up since it was unexpected.
As a result, the change in rates at the Fed’s monthly meeting is as important as the commentary and Q&A session to follow! If the markets know what to account for moving forward, the markets can prepare.
This cause-and-effect relationship between the Fed and MBS historically has resulted in a spread of around 2%-3% between the Fed funds rate and a typical mortgage rate. If the Fed funds rate is at 2%, we can expect mortgage rates to be around 4%-5%.
Next, why do you see different rates from different companies—some much lower than you’d expect after reading the news headlines? This is often the result of good marketing, and a best-case scenario customer!
For example, a company might advertise a rate for a hypothetical person with perfect credit, little/no debt, with a 25% down payment—a pretty unrealistic scenario. Read the fine print and make sure you don’t fall prey to shady practices. Find a trustworthy company and understand the rate and fees (application, loan origination, etc…) that are associated with what you’re quoted.
With this laid out, where do things stand today?
Last month, the Bureau of Labor Statistics released Consumer Price Index data for October, which showed that inflation slowed more than expected, dropping to an annual rate of 7.7% — 0.5 points below September's rate.
This was better news than we expected, and as a result mortgage interest rates fell by more than ½ a percentage point almost immediately. The average 30-year fixed rate as of today hovers around 6.65%--down from 7.25% just a few weeks ago.
At the December meeting it’ll be interesting to see if October’s inflation numbers were a fluke, or if inflation has really peaked and is now trending down. We’ll also see if the Fed’s actions have hit the economy harder than expected now that all of fall’s data is in.
If we see a pivot is on the horizon, we’ll likely see rates drop which sets us up for a healthy and neutral market in 2023 with steady demand, reasonable rates, and sellers willing to sell because the spread between their current rate and the new market rate. And since most buyers are also sellers, a neutral market is truly best for all.