In a significant blow to the housing market, mortgage rates have surged to a level not seen in 22 years, putting pressure on homebuyers already grappling with soaring prices.
According to Freddie Mac’s recent report, the average rate for a 30-year fixed-rate mortgage in the United States has reached 7.23%, marking the highest rate since June 2001. This surge in rates has dampened the demand for homes, leading to a notable decline in sales of existing homes compared to the previous year. Many sellers, who locked in low rates during the pandemic, are now hesitant to list their homes for sale due to concerns about securing an equally favorable rate when they make their next purchase.
Several factors influence mortgage rates, with the bond market playing a significant role. Mortgage rates tend to follow the yield on the 10-year Treasury bond, considered a safe investment backed by the U.S. government. Lenders generally base their rates on this benchmark, often referred to as the risk-free rate, and adjust it to account for the higher risk associated with borrowers such as homebuyers.
The recent increase in the yield on the 10-year Treasury note, reaching its highest point since 2007 at 4.3%, is a reflection of the Federal Reserve’s efforts to curb inflation by raising borrowing costs. The Fed, responsible for setting short-term interest rates, heavily influences yields on long-term bonds through market expectations.
When inflation runs high, the Fed raises short-term rates to slow down the economy and alleviate pricing pressures. However, higher interest rates make borrowing more expensive for banks, prompting them to raise consumer loan rates, including mortgages, to compensate. This trend has persisted for over a year, with the Fed’s rate climbing above 5% from near zero, subsequently causing mortgage rates to follow suit.
Mortgage rates are also affected by a strong economy. A thriving job market leads to increased household spending power, driving up demand for mortgages and subsequently raising rates.
Lenders frequently bundle mortgages into portfolios and sell them to investors as mortgage-backed securities, similar to bonds. To remain competitive with the 10-year Treasury bond, lenders must increase the yields on these securities, resulting in higher mortgage rates. The gap between the yield on the 10-year Treasury note and mortgage-backed securities, known as the spread, typically stands at around 2 percentage points. Presently, the difference is closer to 3 percentage points, exerting a significant impact on the housing market by pushing mortgage rates higher.
Experts predict that mortgage rates will remain elevated for at least a few more months. Even when they begin to decline, they are expected to settle well above the pre-pandemic rates of around 3%. Chief economist Lawrence Yun from the National Association of Realtors anticipates a gradual decrease, with rates possibly dropping to 6% by spring as the Federal Reserve eases its rate increases. The Mortgage Bankers Association, on the other hand, forecasts a decrease to 5% by the fourth quarter of next year.
While the current high mortgage rates pose challenges for homebuyers and the housing market, there are expectations that they will gradually subside in the coming months, albeit settling at a higher range than the historically low rates observed during the early stages of the pandemic.