When it comes to countertops, square footage and lot size, your clients are well informed and know exactly what they want. However, understanding more complex matters like mortgage rates can be confusing and even overwhelming for home buyers and sellers. To help our associates better serve as their clients’ local economists, Keller Williams is initiating a new series called Market aha’s. The goal is to provide important industry data in an easy-to-explain manner. The quarterly series will cover mortgage rates, price changes, inventory, GDP and unemployment data. This is the first article in the series.
The Facts: Mortgage Rates Are Down
Earlier this year, it was anticipated that rates would be higher now than they are. However, despite a slight increase in rates over the summer, the current rate for a 30-year fixed-rate mortgage is 4.19 percent according to Freddie Mac. What is the mystery behind these historically low rates and what does this mean for your clients looking to buy or sell now?
The aha: Don’t Wait to Buy or Sell. Rates Are Expected to Rise
Mortgage rates are more than just the interest rate on a homeowner’s mortgage. Understanding how they are determined and what affects them can help your clients make more informed real estate decisions. Many people think mortgage rates are controlled by the Federal Reserve and can be arbitrarily turned up or down at any given time. While the Fed affects the rates, it does not act alone. Here are the five main factors that affect mortgage rates:
1. Federal Reserve Policy. There are two actions the Fed can take that affect interest rates. First, the Federal Reserve can change the Federal Funds Rate by altering short-term treasury securities investment levels. When the Fed purchases more bonds, mortgage rates tend to go down and vice versa. When the Fed talks about raising interest rates, they are talking about the Federal Funds Rate, which is the rate banks charge each other to borrow money (known more commonly as interbank lending). Currently the Federal Funds Rate is practically at zero percent and has been there for a while. The Fed has stated that this rate is likely to rise within the next year.
The second action the Fed takes that affects interest rates is the purchasing of assets, such as long-term treasury securities and mortgage-backed securities, which historically has not been part of monetary policy. However, the Fed has been slowly reducing its purchases of these types of assets and has stated it will cease all purchase activities next month.
2. Bond and Treasury Investments. Bond purchases are not exclusive to the Federal Reserve. Private investors can also purchase bonds. When more bonds are purchased, prices rise and the yield (the amount of return an investor will realize on a bond) goes down. This matters because mortgages are essentially bonds and their rates compete with the rates of other investments. If the interest rate on bonds decreases, that downward pressure is applied to mortgage rates and they fall as well. Recent increased purchases of these short-term investments are likely due in part to the volatility in foreign markets, which is driving funds into U.S. treasuries, thus lowering the yield. As global affairs stabilize, money is likely to move out of U.S. markets and drive interest rates up.
3. Mortgage-Backed Securities. A mortgage-backed security is an investment tied to mortgages. Private banks sell mortgages to Government Sponsored Enterprises (GSEs), which then bundle multiple loans and sell them to investors as mortgage-backed securities. These long-term investments affect the market because as demand increases, banks have incentive to create more supply, which puts downward pressure on interest rates.
4. Housing Market Activity. When the housing market is strong, there is more demand for home loans and banks can charge higher rates. This is a classic example of supply and demand. The current housing market is balanced and healthy with indicators pointing toward more development in the future.
5. Current U.S. Economic Climate. When the economy is strong, people have more money to spend. Slow economic activity at the beginning of 2014 coupled with the fact that inflation levels remain below the target of 2 percent, have likely had some downward effect on mortgage rates by boosting the real return of given nominal rates. The economy is expected to continue a steady pace for the remainder of 2014.
Although your clients may be tempted to wait for rates to fall, there is no guarantee they will. Historically, rates have been much higher and most indicators suggest they will rise soon. Compared with the average 30-year rate from 1990-2004 of 6.7 percent, 4.1 percent doesn’t look bad. Although there are no guarantees, evaluating and understanding the five factors above will allow you to provide an informed prediction as to which way interest rates will shift.