The Federal Reserve will hike interest rates this year and continue rising throughout next year. Will there be a direct correlation between the increase in Fed rate and mortgage rates? If so, will the fixed mortgage rate or the flexible mortgage rate be affected? This much-anticipated act by the Fed does not guarantee an automatic proportionate rise in mortgage rates. Let’s consider the facts that explain why there may be no direct correlation between the mortgage rates and the changes in the Fed’s rate.
Mortgage rates are influenced by a number of factors apart from the feds rate. Over the course of 15 years, the feds control short-term federal rates and long-term 30-year fixed mortgage rate. This shows to some to an extent there appears to be some influence on the two rates but not significant.
Rates are showing independent movement, even when there are no changes to the Fed funds rate during that period. For example, it is noted that the Federal Reserve hiked the short-term reserve by 4.3 percent between mid-2004 and 2006. Surprisingly, the mortgage rate bounced around a narrow increase of 0.5 percent. This shows that the influence of the Federal Reserve rate hike on the percentages was negligible. We need to clarify why.
Long-term standard rates are influenced by the market forces of demand and supply. These forces are a combination of many factors. So, the Fed’s short-term rate is a single factor out of the many factors that guide the mortgage amounts. Other determinants include the inflation rate that has a direct impact on mortgage rates. Low inflation rates indicate low prices and low-interest rates on mortgage products.
As inflation increases, mortgage interest rates also increases. The erosion of the purchasing power of money also influences the mortgage percentages. A decline in purchasing power of a dollar means that we need to pay more, hence mortgage rates also increases. Therefore, this is an inverse relationship with the mortgage rates.
The global reserve currency status also influences the mortgage rates. The available reserve can be used to pay off international debt obligations or to influence the domestic rates. Other factors include the budget deficit and debt, corporate borrowing enthusiasm, household saving rate, the degree to which the government will guarantee mortgages and household savings rate.
Furthermore, the timing of the fed’s rate hike is not an event for the mortgage industry. May it be on September or October; the housing market will remain unchanged. However, consumers need to be aware that the current zero interest rate will not remain. It will increase in the next two years such that by mid-term elections of 2018, The Fed fund rate will have reached 2.5% or a bit higher.
Also, if the inflation rates increase, mortgage percentages will be even higher. Housing shortage can persist if home building lags behind population growth. This has a ripple effect on housing market; apartment rents and owner equivalent rents rise, these two measures comprise a large weight of about 30 percent in the total consumer price index. Inflation can also be on the increase if the budget deficit situation worsens in the future. If there will be no credible plan to finance the systems, we end up printing more money.
We can be optimistic that mortgage rates will be manageable if we assume that the home builders will be able to cope with the increasing demand. In the past years, the average mortgage rate was ranging from 8 percent to 13 percent over a three-decade period (The 1970s, 1980s, and 1990s). Therefore, there is no need to be worried should the anticipated rates rise to six percent.
The rising mortgage rates will also be attributed to the right reasons such as the economic growth and more job opportunities. Also, mortgage underwriting will have fewer rules as the default rates have significantly reduced in the past. The mortgage market will be fine, and consumers will be able to absorb slightly higher rates.