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What Factors Are Driving Mortgage Rates Higher and How Long Will They Remain Elevated?

Mortgage rates are currently at a 22-year high, impacting the housing market already affected by high prices.

The average rate on a 30-year fixed-rate mortgage, which is the most popular home loan in the US, is 7.23 percent, as reported by Freddie Mac on August 24. This is the highest rate since June 2001.

The increase in rates has reduced the demand for homes, resulting in a significant drop in sales compared to last year. Additionally, sellers who secured low rates during the pandemic are hesitant to put their homes on the market for fear of not being able to find a comparable rate when they become buyers.

There are several factors influencing mortgage rates, with the bond market being the main driver. However, the economy is more complex, according to Melissa Cohn, the regional vice president at William Raveis Mortgage, a real estate lender.

The bond market sets the foundation for mortgage rates. Mortgage rates, along with other long-term loans, tend to follow the rate or yield on the 10-year Treasury bond. This bond is considered safe for lenders as it is backed by the US government. Lenders typically start with this rate, known as the risk-free rate, and increase it to account for the higher risk associated with borrowers like home buyers who may not repay the loan.

The yield on the 10-year Treasury note recently reached its highest level since 2007, standing at 4.3 percent. This increase reflects the Federal Reserve’s efforts to control inflation by raising borrowing costs. The Fed influences short-term interest rates, and the expectation of future rate changes greatly impacts yields on long-term bonds.

When inflation is high, the Fed raises short-term rates to slow down the economy and reduce price pressures. However, higher interest rates make borrowing more expensive for banks, causing them to increase rates on consumer loans, including mortgages. This has been happening for over a year, as the Fed’s rate rose above 5 percent from nearly zero, with mortgage rates following suit.

A strong economy also affects mortgage rates. A thriving job market provides households with more disposable income, increasing the demand for mortgages and thus raising rates.

Furthermore, lenders often bundle mortgages into a portfolio and sell them to investors as mortgage-backed securities, similar to bonds.

To remain competitive with the 10-year Treasury bond, lenders need to raise the yields on their mortgage-backed securities. This ultimately leads to higher rates for home loans. The difference between the yield on the 10-year Treasury note and mortgage-backed securities, known as the spread, is typically around two percentage points.

Currently, the spread is closer to three percentage points, significantly impacting the housing market by pushing mortgage rates higher. Lawrence Yun, the chief economist at the National Association of Realtors, finds it puzzling that the spread is this wide and enduring.

He stated, “It is really puzzling that the spread is this wide and quite persistent.”

Economists predict that mortgage rates will remain elevated for at least a few more months. Even when they eventually start to decline, they are expected to settle well above the low 3 percent rates seen during the early stages of the pandemic.

Mr. Yun believes that rates will begin to decrease by the end of the year, possibly dropping to 6 percent by spring. He argues that the rates should be lower based on rationality and economic logic, mentioning that the Fed has already slowed down its interest rate hikes.

The Mortgage Bankers Association, an industry group, recently forecasted that the average 30-year mortgage rate would decrease to 5 percent by the fourth quarter of next year.

Federal Reserve officials have acknowledged that they need to consider the potential economic costs of raising rates. Mr. Yun believes this also includes the impact on regional banks, such as the collapses of Silicon Valley Bank and Signature Bank.

Home buyers may feel limited in their options, but there are steps they can take to secure a lower rate, as advised by Melissa Cohn from William Raveis Mortgage.

Having a strong credit score and a substantial down payment, typically at least 20 percent of the purchase price, are essential. Buyers who can meet these criteria may find themselves in a less competitive market, facilitating the closing of a deal.

Ms. Cohn stated, “Rates should be lower in the next 12 to 24 months,” suggesting that home buyers can refinance their mortgage when rates drop.

She also advises consumers to compare rates from multiple lenders, as there are no magical solutions. “You need to shop around,” she emphasized.

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