Usually, there’s no telling where rates will go.
But thanks to our federal government’s gazillion-dollar bailout of the capital markets, I (with the help of a few economists) can make a pretty good guess at what’s going to happen to rates in the next couple months. If you just want the answer and what to do about it, skip to the last two sections. If you want to know how we know this, read on.
Mortgage rate movements loosely track the ups and downs of Treasury rates. Historically, the rate on a 30-year, fixed-rate mortgage has been about 1.7% higher than that of a 10-year Treasury bond. Treasury bonds give a guaranteed rate of return—the federal government’s never defaulted on its debt. Since mortgage bonds will default if owners stop making payments, investors require that 1.7% extra on top of the Treasury rate to compensate them for the extra risk.
Lots of things can affect that 1.7 percentage point spread. The one that matters the most—some economists might argue, the only one that matters—is the health of the capital markets. Mortgage bonds are packaged into securities that investors trade on the open market. Strong investor demand for mortgage bonds drives rates down. Weak demand drives them up.
What’s different now
In 2008 and 2009, mortgage-backed securities became one of the most hated investments on Earth. With home prices dropping and the country bleeding jobs, mortgage-backed securities went from being investors’ favorites to the trash heap. That 1.7% spread didn’t seem like enough to compensate them for the risk anymore, and so, mortgage rates soared.
That didn’t sit well with the folks at the Federal Reserve. Without a well-functioning mortgage market, the housing black hole would only get worse. So they concocted a plan to kill two birds with one stone. They needed to flood banks with cash just to keep them afloat. Although the Fed normally did that by buying Treasury bonds from banks, this time Fed governors decided to do it by buying securities like mortgages. That way, banks would get the break they needed, and mortgage rates would go down. In the end, the Fed expected its mortgage holdings to total $1.25 trillion.
So now—even though home prices are still falling, and regular investors are still spooked by mortgage-backed securities—30-year mortgage rates are still only about 1.7 percentage points higher than 10-year Treasury rates. (1.64 points higher, to be exact)
Why rates will go up in March
Thing is, the Fed can’t continue to buy mortgages for forever. Eventually, they’d give banks way too much cash, which could lead to inflation. So they have a date when they plan to stop buying them: March 30.
How will that impact rates? The president of the Boston Fed thinks they’ll rise up to three-quarters of a percentage point. That could happen when the Fed actually stops buying or in the run-up to the end of the program, as investors anticipate the change. Of course, he could be wrong if the Fed decides to extend the program somehow. The Fed’s already extended the program once—it was originally supposed to end last year.
So what should you do about it?
Don’t rush out to buy a home. With prices still dropping in most areas, waiting for a lower price will probably outweigh the cost of an increase in rates, unless you plan to actually own your home for 30 years.
But the change does put pressure on owners who’ve thought about refinancing. Right now, 30-year fixed mortgage rates stand at about 5.47%. That would make your monthly payment $1,131.81 on a $200,000 loan. If you waited to refinance until April, when rates have risen to 6.2% or so, you’ll end up paying an extra $95.72 per month. Over a year, that’s almost $1,150. Waiting would cost you more than an extra mortgage payment a year!
The cost to refinance is typically a couple percentage points of the loan value. So refinancing a $200,000 loan would cost at least $2,000 and probably more. So if you’d save $100 a month by refinancing, you’d want to be fairly sure you were going to stay in the house for another 20 months at a minimum. Here’s a calculator where you can do the math on your own home.
It’s not often we get a crystal ball showing us the future of mortgage rates. Take advantage!