We have a number of millennial clients looking to purchase homes for the first time this Spring. A popular question among them has been what type of impact will the Fed raising interest rates have on mortgage rates? First, it’s important to understand that we are talking about two different kinds of interest rates here. There’s mortgage rates, which is the amount of interest you’ll pay on a loan to purchase a home. Then there is the federal funds rate, which is the interest rate the Fed will be raising next month.
Mortgage rates are set by the market
While the federal funds rate can and does influence mortgage rates, it isn’t a binary relationship. Meaning, that just because the Fed is raising the federal funds rate next month, that doesn’t mean mortgage rates are going to automatically go up as well.
The federal reserve has kept the federal funds rate at 0% since March 2020. This rate has not changed in almost two years even though other interest rates have gone through major fluctuations over the same period. So what impacts mortgage rates the most? The bond market, and generally speaking, interest rates have been rising in every corner of the bond market for the last three months. This reflects the market’s expectations that the Fed will soon be raising the federal funds rate.
Here we arrive at the most important point of our article: mortgage rates do not need to wait for the Fed to start raising rates before adjusting higher on their own. If the bond market believes that the Fed’s key interest rate is going higher, then interest rates everywhere are usually repriced higher. This is why there is a strong relationship between the 30-year fixed mortgage rate and the 10-year US Treasury yield, with the former following the direction of the latter.
Mortgage rates have already risen
Beginning in mid-December, the bond market started to anticipate that the Fed was going to begin raising interest rates. As a result, market interest rates everywhere started rising and haven’t yet stopped. The 10-year treasury, for example, has risen from about 1.40% to nearly 2.0% in the last two months. As far as bond market moves go, especially post-2008, this has been an extremely fast rise in the 10-year yield. Mortgage rates have followed suit, rising from about 3% to almost 4% over that same time.
To reiterate, the fed hasn’t even done anything yet, but they’ve communicated very clearly what they are going to do. As such, the market has already started to price in a higher interest rate environment, including for mortgage rates. Therefore, we do not expect a substantial rise in mortgage rates immediately following an increase in the federal funds rate. Notice in the chart below that, historically, all three rates have typically risen together:
Again, the only reason the federal funds rate hasn’t risen yet is because the Fed hasn’t raised it. But that will change next month. Overall, the market expects this rate to be between 1.50-2.0% by the end of the year.
So where will mortgage rates go?
Mortgage rates will continue to follow the overall trend in the 10-year US treasury yield. In anticipation of a higher federal funds rate, the 10-year yield has risen to a 2-year high around 2%. We expect the 10-year to finish the year between 1.75-2.50%. The last time the 10-year yield rose to 2.50%, the 30-year mortgage rate rose to 4.50%. So if you are in the market for a home this spring, you will be confronted with higher mortgage rates than one year ago.
In the grand scheme of things, mortgage rates remain low when evaluated over a 30-year time frame. If you are concerned that mortgage rates are going to soar over 5% once the fed starts raising rates, we don’t think you have reason to worry. Current mortgage rates already reflect the forthcoming increase in the federal funds rate. While mortgage rates may trend higher from here, the move should be relatively muted compared to the increase of last two months.
By the way, if you are local to the Chicagoland area, and will be in the housing market this spring… we have a number of real estate agents and loan officers in our referral network. Feel free to reach out with any of your housing market questions!
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