Mortgage rates are a hot topic right now, especially as the markets have been on government life support for the past 15 months. Now all the chatter is about what will happen when the government cuts these funds? With rates on the rise soon, understanding the relationship between higher mortgage rates and what buyers will be able to afford is going to be very important.  

Changing rates affect buyer budgets and loan approvals. Higher interest rates are going to affect buyer’s budgets, while also affecting any current offers or loan approvals they may have.  

For example, a pre approval that the buyer has had for 3-4 months at 5% that stretched their budget might be no good when rates jump up to 5.5% or 6%. Perhaps they will not be able to afford the higher payment anymore and they will need to start shopping all over again for lower priced homes. For example the payment increases $251 a month for a $400k loan going from 5% to 6%, this is a lot of money for a family of 4 or 5. These will be conversations that will need to take place over the next few months if and when rates go up and buyers are not in contract yet.  

A simple guide to understanding mortgage rates Understanding mortgage rates is quite simple. Mortgage rates are traded everyday as mortgage backed securities/mortgage bonds (MBS) just like stocks. They either go up or down in price on a daily basis. Here is a picture of a MBS trading chart over the past 7 months below. When MBS are trading low mortgage rates are high and when MBS are trading high mortgage rates are low.

MBS Prices vs Average 30 year Fixed Mortgage Rates     

When MBS trade lower, lenders raise their rates and distribute “Reprices for the Worse” (see chart below) and republish these higher rates to the public. This trading of MBS directly correlates to the cost of mortgage rates we see everyday from lenders.’

 When MBS Trade Lower Mortgage Rates Increase 

What economic events force mortgage rates to go up or down?  
So what causes mortgage rates to go up or down and MBS to trade higher or lower? These are tied to some fundamental economic activities that take place everyday in our markets, by understanding these you will now be able to predict what direction rates will probably go for your clients.  

Stocks and bonds (MBS) compete everyday for investors dollars in the open markets, stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky. Remember: When there is weak economic news (higher unemployment etc), this normally causes money to flow out of Stocks and into more stable Bonds, helping Bonds and home loan rates improve, while strong economic news(lower unemployment, more homes sold etc) normally has the opposite result so investors will put their money into more risky stocks, thus causing mortgage rates to increase. It is an interesting dynamic that generally bad economic news is good for mortgage rates!  

Inflation is going to be a problem soon because of all this money that is being printed to pay for Government spending. So how will this affect mortgage rates? The bottom line is that as inflation increases, home loan rates will rise too. That’s because lenders know that a rise in inflation actually diminishes the value of the money they receive over the life of a loan, as the money they receive for payment simply won’t go as far. So when they see changes in inflation or even anticipate a rise, they increase their interest rates to make up for the loss in future buying power that will happen as a result of inflation.  

Also, when you hear the Federal Reserve talk about possibly raising their federal funds rate, or their discount rate (they raised this .25% last week), this does not affect mortgage rates directly.   

The 800 pound gorilla in the room..Rates are artificial right now!

It is imperative that all buyers understand that interest rates are artificially low right now! In November 2008, the Fed put into place their mortgage backed securities (MBS) buying program to artificially lower rates. They were able to keep rates between 4.875-5% throughout 2009.  

The Feds Artificially Kept Rates Low During 2009  

That program though is due to end on March 30th 2010 and they have announced they will not be extending it. So rates are sure to increase. The only questions remaining are by how much and when?  Here is a great article written in the San Francisco Chronicle newspaper this past week that discusses how the markets and interest rates have been on government life support for the past year, there are many experts advising that interest rates are set to rise to possibly 6% and higher. Here is a copy of the article. San Francisco Chronicle Newspaper article  

Make sure you know your maximum payment budget for buying a home!

Make sure you are starting to have conversations in regards to this topic of increasing interest rates. If and when rates rise, you need to know beforehand if a higher mortgage payment still fits in your budget, otherwise all those days spent looking at homes in a particular price range will be to no avail, a higher interest rate equals a higher mortgage payment and may put you out of your price range.

I hope you found some of this information helpful. Feel free to contact me if you have any questions about interest rates or need help getting approved for a home loan. I study market information daily and make sure my clients always have accurate information and the lowest rates. I also have had conversations with all my buyers about their budgets, so they know that a higher rate and payment may be around the corner, just in case they do not get into contract by the end of March or April. Make sure you know too what your maximum budget is for your new home loan payment.

Sincerely

Michael