Whether purchasing your first home, your “forever home,” or even your retirement home, the questions looms: when should I buy? Considering interest rates are on the move, it’s a natural question and one worth addressing. So, let’s dive in shall we?
What’s happening with mortgage rates?
This is a good time to look back on some of my college economics classes. What I remember (after waking up from my class nap) is that The Federal Reserve uses short-term borrowing rates (referred to as the fed funds rate) to influence the economy. Their goal is to balance economic growth, unemployment and inflation. When inflation starts picking up (usually due to a thriving economy), increasing short-term rates helps to manage the economy from overheating. That commitment happens as long as the economy stays strong. Ideally, they are trying to get the formula perfect so people spend money, borrow money, and save money. In the end, these changes in short-term rates by the Federal Reserve begin to trickle through the debt markets into Treasury bonds and mortgage rates.
How (and why) do Treasury rates affect mortgage rates?
The reason Treasury rates have a defining impact on mortgage rates is quite logical when you break it down. Treasury bonds are issued by the US government. Since we are considered the World Bank when we issue bonds (or debt), it is basically considered a “risk free” investment. Therefore, default is not an option. In doing such, these bonds set the rate for what debt (or borrowing) rates should be in the economy. To be clear, when the Treasury rate increases, all bond (or debt like instruments) generally follow suit. Think about it in these terms — why would anyone purchase a bond which pays lower than a risk-free investment such as a Treasury? The simple answer is, they wouldn’t.
When we look at mortgages, they are no different. As the Fed increases short-term borrowing rates, the mortgage world has to keep up. Naturally, banks want to bundle and resell their mortgages as investments. Treasuries are great instruments on which to base mortgages, since they are long term in nature (generally issued in 10, 20, or 30-year increments). Since Treasuries are such a stable investment, the only way to entice someone to purchase a bundle of “riskier” mortgages is to issue new mortgages at higher rates than their Treasury counterpart. This leads to a correlated relationship between Treasury prices and bond prices.
The history of mortgage rates.
It’s important to recognize we have been in a historically low interest and mortgage rate environment since 2008. Interest rates recently hit all-time lows at just over 3% for a 30-year mortgage. Prior to the Great Recession, mortgage rates were more normalized at just over 6%. Today, we see rates rebounding from their lows. Currently, 30-year mortgage rates hover around 4.5%-5%.
Check out the below chart from ValuePenguin. You’ll see rates have declined since the hyperinflation days of the early to mid 80’s.
Historically speaking, the average 30-year mortgage rate since the early 70’s is a little over 8%. However, it’s important to note that we haven’t seen 8% mortgage rates since the year 2000. If you take out the outlier years of the early to mid-80’s, these average rates are more in the 6% range. In 2019, the experts predict we’ll see rates between 4.8% and 5.4%. Longer term, we’ll land in that 5.5%-6% rate (which they feel is a comfortable place to be).
What should I do if I want to purchase a home?
No one actually knows what the future holds; all these things above are sheer predictions. Conventional wisdom suggests rates will continue on this slow climb until they find a natural level. These are good guidelines if you are looking at purchasing your next home.
In my experience, there are always a lot of things to consider when purchasing that new home. One such item is if interest rates increase, housing prices start to cool off. So waiting may lead to a cheaper purchasing price on that home, but paying more for your next mortgage. I firmly believe in making sure you are ready before you go make that commitment. However if you are ready and able, now is as a good as time as ever to take that big leap!