Mortgage Rates: Not Set by Fed and Maybe Not So Bad

I keep hearing people say over and over that the Fed raised mortgage rates again, and that’s just not how this works. Although the Federal Reserve does not set mortgage rates, its decisions do play a role in how mortgage rates move up or down.

So what does the Fed do? Well to oversimplify things: they set borrowing rates for what banks pay to borrow money from the Federal Reserve. When borrowing costs banks more, they charge more for the money they lend including credit card rates (and adjustable-rate mortgages). This in turn causes people to borrow and charge less thereby spending less which helps curb inflation. That's why the Fed has been raising rates quite often recently. They're trying to curb inflation.

In truth, fixed mortgage interest rates track the 10-year Treasury yield more closely than the Fed rate. They aren’t the same rate, rather mortgage rates mirror the 10-year Treasury yield with typically about a 1.75 percentage point gap. That gap is currently at more than 3 percentage points, however. Traditionally, this spread widens when markets fear a recession.

The 10-year Treasury yield isn’t the only factor determining mortgage interest rates. Rates tend to rise with inflation, too much demand for mortgages, and lower demand in the secondary mortgage market (where investors buy mortgage-backed securities).

Here's a look at recent mortgage rates. Gone are the days of 2% mortgages. This steady increase in mortgage rates over the last few years has caused many potential buyers to delay purchasing a home either because they think the rate will drop again or because they can no longer afford at 7% interest what they could have afforded at 3%.

You may want to rethink that position, though. As you can see, the prices after dipping at the end of last year, are on the rise again. It's a much slower rise than the drastic jump at the end of 2021 and beginning of 2022, but they are rising. So by the time you've waited for the rates to drop, you'll end up paying possibly significantly more for the same house. You will likely also have a lot more competition because everyone else is waiting to buy as well, and we are still in a significant housing shortage.

Here's something else to keep in mind. Although it may be a long time before we ever see 2% mortgage rates again (if we ever do), the current rates in the 7% range is not really that bad when you look at rates further back. Imagine rates at nearly 19% where they were in 1981. From 1971 to 2023, the average 30-year fixed mortgage rate is 7.74% which is pretty much right where we are now.

Most predictions do anticipate mortgage rates dropping to 5%, 4% or even the 3% range within the next several years, but how much is the house going to cost you then? The saying in real estate is "marry the house, date the rate." In other words, buy the house you want (and can afford) now, and when the rates improve, refinance to a better rate.