Understanding the factors that influence mortgage rates can help you better navigate the home-buying process. Here are some key elements that play a role:
- Economic Conditions: The overall health of the economy significantly impacts mortgage rates.
During periods of economic growth rates tend to rise as consumer demand for loans increases more than investor appetite for mortgage bonds.
Conversely, during economic downturns, rates often fall due to decreased consumer demand for loans and increased investor demand for the relative safety of mortgage bonds.
Mortgage bonds are considered "safe" investments because of the implicit guarantee by the federal goverment. As the demand for a bond increases, the price of the bond increases, which lowers the effective interest rate paid when you own the bond.
- Inflation: Inflation refers to the rate at which the general level of prices for goods and services rises.
When inflation is high, investors demand higher interest rates to compensate for the decrease in the relative value of the mortgage bond. Conversely, low inflation typically leads to lower mortgage rates.
- Federal Reserve Policies: The Federal Reserve, or the "Fed", influences interest rates through its monetary policy.
The Fed sets the "federal funds rate" which is the interest rate at which depository institutions (such as banks and credit unions) lend reserve balances to other depository institutions overnight.
The Fed uses the federal funds rate to manage the rate of inflation and to stimulate employment.
When the Fed raises the federal funds rate they believe that there is an increased risk of inflation.
The rates on other debt securities like longer term Treasury bonds, corporate bonds, and mortgage often will often go up.
Conversely, when the Fed lowers rates they believe that inflation is under control and mortgage rates will typically go down.
It is not a 1:1 relationship. Overnight federal funds rates and longer term mortgage rates tend to move together, but a 0.5% decrease in the federal funds rate does not necessarily mean a 0.5% decrease in mortgage rates.
Also, the bond market continuously prices in the expected future moves by the Fed.
In September 2024 the Fed cut overnight rates by 0.50% and mortgage rates actually went up. The Fed's commentary said that inflation was still high and that they did not expect rates to decline as quickly as originally thought.
The mortgage market had been expecting a steady decrease in rates. The change in the long term picture caused mortgage rates to increase.
There were two more federal funds rates cuts in November 2024 and December 2024.
After each of these Fed cuts mortgage rates went higher, again because the Fed's commentary said that inflation was still persistent and that future rate cuts might take longer.
As of December 11th, 2024, Fannie Mae was forecasting mortgage rates around 6.60% in 1st quarter 2025 and dropping to 6.20% by the end of the year.
- Bond Market: Mortgage rates are closely tied to the yields on long-term government bonds, particularly the 5-year and 10-year Treasury Notes.
People tend to keep their homes for 5-7 years, even though they have a 30 year mortgage.
When Treasury bond yields rise, mortgage rates tend to increase. Conversely, when Treasury bond yields fall, mortgage rates usually decrease.
Historically 30-year mortgage rates have been about 1.8% above the 10-year Treasury Note rate. In 2024 mortgage rates have been about 2.6% higher. See the graph below.
- Lender Competition: The level of competition among lenders can influence mortgage rates.
When many lenders are competing for business, they may offer lower rates to attract borrowers.
Conversely, in a less competitive market, rates may be higher.
Some markets like Alaska have less competition because lower 48 regional lenders see the market as too small and too remote.
- Lender Capacity:
In first quarter of 2024 the number of mortgages originated was $402 billion, which is about where it has been since rates went up in Q2 of 2022, and about where is was pre-2019.
In Q4 of 2022 there were $1,357 billion of mortgages originated, which were mostly refis. People were refinancing to rates below 3%.
Mortgage lenders in 2020 and 2021 increased their rates because they couldn't handle the volume.
In 2024 mortgage lenders are keeping their rates as low as possible to attract business. Many lenders are originating loans at a loss just to stay open.
- Borrower-Specific Factors:
Your personal financial situation also plays a crucial role. This includes your credit score, debt-to-income ratio, employment history, and the size of your down payment. Borrowers with strong financial profiles typically qualify for lower rates.
By understanding these factors, you can better anticipate changes in mortgage rates and make more informed decisions when securing a home loan.
