There have been some intriguing headlines circulating today about the potential for mortgage rates to go as high as 8% — and potentially stay much higher for longer than many think. Indeed, following yesterday’s Federal Open Market Committee (FOMC) meeting, the Federal Reserve has made it excruciatingly clear that a “higher for longer” stance is likely going to be in place for the markets.
Long-term bond rates have risen, driving the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) lower today. This move in long bond rates, upon which certain mortgages are based, could drive borrowing rates higher for homebuyers. Thus, the expectation is that home prices could come under even more pressure, even as supply shortages keep prices relatively stable for the time being.
Comments from Lawrence Yun, Chief Economist at the National Association of Realtors, have stoked bets that mortgage rates could rise to the 8% level. Yun suggests that “It is possible that mortgage rates may go up to 8% in the short run before by the spring of next year retreating.” For those looking to buy or upgrade their housing, that’s not a great thing.
Certainly, higher interest rates are likely to flow through to mortgage rates. This is something investors and homebuyers will be watching closely. However, there’s another reason why I think the experts could be right.
The Mortgage Rate Surge Could Continue
Higher interest rates are one key component (and the primary driver) of mortgage rates. Essentially, if all banks and lending institutions are forced to borrow money at higher rates, they’re going to pass that onto borrowers, capturing the spread between the two (net interest margin). This is the key factor many attribute to the potential for 8% mortgage rates on the horizon.
However, the other key component that doesn’t get much attention from the financial media is the mortgage-backed securities (MBS) markets. For years since the Great Recession, the Federal Reserve has been the biggest buyer of MBS, helping to keep mortgage rates low and stoking the economy. Demand for MBS allows mortgage originators to originate a loan and have assurance that they can sell the mortgage to companies compiling mortgages together into bonds at a fair price. Those companies then sell those mortgage bonds to institutional investors and the Fed.
Thus, with quantitative tightening happening at the same time as interest rate hikes, both lower demand for MBS and higher interest rates appear to be stoking mortgage rates. I think both are important and should be taken into consideration when thinking about why mortgage rates could remain higher, even if interest rates stay steady or of there’s a signal that rates could be cut at some point.
It’s a supply-and-demand game in the mortgage bond market and, right now, there’s little demand for these bonds. Less demand for MBS means originators have to pay a higher fee to sell their bonds, which drives up mortgage rates as well (originators aren’t going to lose money, either). The Fed could begin buying mortgage bonds en masse to support lower mortgage rates, but that’s not what they’re trying to do right now. Thus, I think homebuyers should get strapped in for higher rates, at least in the near term.
On the date of publication, Chris MacDonald did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
