Written By: Joel Palmer, Op-Ed Writer
After years of suppressing interest rates as low as possible, the Federal Reserve has increased the federal funds rate by 50 basis points over two rate increases in the last year. The Fed also projects three rates increases annually for the next three years.
Assuming these rate increases occur, what impact will they have on the mortgage industry, which has benefitted from historically low borrowing rates since the financial meltdown in 2008?
There is not always a direct correlation between movement in the federal funds rate and mortgage rates. In fact, the opposite often occurs.
Following the 25-basis-point increase in the federal funds rate in December 2015, average 30-year mortgage rates fell from just under 4 percent that month to below 3.5 percent by the summer of 2016, according to Freddie Mac. And over the last two decades, the federal funds rate and the average 30-year fixed rate mortgage rate have differed by as much as 5.25 percent.
But while movements in the federal funds rate do not directly impact mortgage rates, they can influence them. In fact, the Fed had delayed interest rate hikes until now largely because of concern about the impact on the housing market.
Mortgage rates are largely determined by the price of mortgage-backed securities set by Wall Street. And those prices are influenced by the Fed’s economic outlook. The more positive that outlook, the higher mortgage rates will typically rise. By raising its funds rate, the Fed is projecting stronger economic growth.
Those economic factors will likely have a more significant impact on mortgage processors and underwriters in 2017 than higher rates will. The job market has strengthened and household incomes are rising, giving more opportunities for people to buy. Plus, there will likely be more inventory available for sale in the coming year as home values increase and bring more existing homeowners into positive equity positions.
According to a National Association of Realtors survey, U.S. home sales have increased in each of the last three consecutive months. And demand remains strong: 67 percent of respondents expressed a desire to own a home in 2016 in its latest survey, up from 53 percent just two years ago. In addition, first-time homebuyers are accounting for the highest share of the market in four years.
One way mortgage demand could be slowed by the current environment is the perception that higher rates will price many out of the market. Consumers may perceive the era of 3 to 4 percent mortgage rates as the “new normal.” After all, it wasn’t that long ago that mortgage rates in the 6 percent range were considered abnormally low because borrowers were used to rates above 7 percent.
If 4 percent is now considered average, anything significantly above that level could be perceived as “too high” for some potential homeowners. But as long as rates rise gradually, demand should not be significantly impacted.
In fact, even with the anticipation of higher rates, the Mortgage Bankers Association has forecasted $1.1 trillion in purchase originations for 2017, which would be an 11-percent increase over 2016 originations.
About the Author
As an NAMU® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.