Winter 2016 Guide to Mortgage Rates

Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market.

Why Mortgage Bonds?

When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other "securitizers". These "securitizers" get their money by issuing bonds to bond market investors.  These bonds are called "mortgage bonds" or "mortgage backed securities".  Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market.

The Role of the Federal Reserve

As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive interest rates down and stimulate the economy.  This is called "quantitative easing" or "QE", and we've had several rounds of QE so far.

Currently, the Fed owns a whopping $1.75 TRILLION in mortgage bonds!
In fact, the Fed has been the biggest buyer of mortgage bonds in recent years. This has had the impact of holding interest rates down to artificially low levels.  In fact, mortgage rates were in the 6.5% - 7% range back in 2006 - 2007 before the Fed started buying mortgage bonds.  That's over 2% higher than where mortgage rates are today.

In December 2015 the Federal Reserve is expected to start increasing short-term interest rates. Economists are anticipating that the Fed will likely slow down or stop their purchase of mortgage bonds approx. a year after they start increasing short-term interest rates. Theoretically, this means that we've got about a year before mortgage rates start going up again... But as you know, the market doesn't always follow theory! Mortgage rates could start going up at any time over the next 12 months in anticipation of these events.

Here are Three Reasons Why It's More Likely for Mortgage Interest Rates to Go Up vs. Go Down As the Economy Improves

• The Fed is likely to slow down or stop its purchase of mortgage bonds as the economy improves. The Fed may even consider selling part of its large portfolio of bonds if the economy improves faster than expected.
• Bond investors are more likely to purchase stocks vs. bonds as the economy improves.

• Bond investors may become more concerned about inflation as the economy improves. However, this is not likely to be a major concern because inflation is still very low and is likely to remain that way for a while.

Here are Three Things that May Impact Mortgage Rates in the Coming Months

• Jobs Report: bond investors and the Fed watch the jobs report and unemployment numbers very closely to determine if the economy is improving and whether they should buy, sell or hold mortgage bonds.
• Inflation Report: bond investors and the Fed watch the inflation reports (CPI and PCE) to determine whether they should buy, sell or hold mortgage bonds.
• Gross Domestic Product (GDP) Report: bond investors and the Fed follow the GDP numbers to determine if the economy is growing and whether they should buy, sell or hold mortgage bonds.  (GDP measures the size of the economy and whether it's growing, shrinking or stagnating.)

Conclusion: we anticipate continued volatility in mortgage rates over the next several months as bond investors and the Fed decipher the economic reports that we've outlined above. Please contact me for more info on which economic reports may impact mortgage rates this week.