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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, which is putting additional pressure on an already expensive housing market.

According to Freddie Mac, the average rate for a 30-year fixed-rate mortgage, the most popular home loan in the US, was 7.23 percent on Aug. 24. This is the highest rate since June 2001.

The rise in mortgage rates has led to a decrease in demand for homes, causing sales of existing homes to decline significantly compared to last year. Furthermore, sellers who secured low rates during the pandemic are hesitant to put their homes on the market because they are concerned they will not be able to find comparable rates when they become buyers.

While the bond market is the biggest driver of mortgage rates, there are other factors at play as well, according to Melissa Cohn, regional vice president at William Raveis Mortgage. She stated that the economy is much more complex than what most consumers realize.

The bond market, specifically the 10-year Treasury bond, is a key determinant of mortgage rates. Mortgage rates typically follow the rate or yield on the 10-year Treasury bond, which is considered a safe investment due to its backing by the US government. Lenders often start with this rate, also known as the risk-free rate, and then adjust it to reflect the higher risk associated with borrowers such as home buyers.

The recent increase in mortgage rates can be attributed to the yield on the 10-year Treasury note reaching its highest level since 2007, currently at 4.3 percent. This is a result of the Federal Reserve’s efforts to control inflation by raising borrowing costs. The Fed sets short-term interest rates, and the expectations for future rate changes have a significant impact on yields for longer-term bonds.

When inflation is high, the Fed raises short-term rates to slow down the economy and alleviate price pressures. However, higher interest rates make it more expensive for banks to borrow, leading them to increase rates on consumer loans, including mortgages. This trend has been observed for over a year, with the Fed’s rate increasing from near zero to above 5 percent, causing mortgage rates to follow suit.

A strong economy also impacts mortgage rates. A thriving job market provides households with more disposable income, leading to increased demand for mortgages and subsequently higher rates.

Lenders often bundle mortgages together into a portfolio, which they sell to investors to raise money. These mortgage-backed securities are similar to bonds.

To remain competitive with the 10-year Treasury bond, lenders must increase the yields on their mortgage-backed securities. This, in turn, 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 driving mortgage rates even higher, as highlighted by Lawrence Yun, the chief economist at the National Association of Realtors.

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

Economists predict that mortgage rates will remain elevated for at least a few more months. And even when they start to come down, they are expected to settle well above the 3 percent rates that home buyers enjoyed during the early stages of the pandemic.

Mr. Yun said he expected rates to begin falling by the end of the year, possibly dropping to 6 percent by spring. “The rationality and economic logic says the rate should be lower,” he said, emphasizing that the Fed has already slowed down its interest rate increases.

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

Fed officials have acknowledged the need to consider the potential economic consequences of raising rates, including the impact on regional banks such as the collapses of Silicon Valley Bank and Signature Bank, as mentioned by Mr. Yun.

Although it may seem that home buyers have limited options, there are steps they can take to secure a lower rate, according to Melissa Cohn of William Raveis Mortgage.

Having a strong credit score and making a sizable down payment, typically at least 20 percent of the purchase price, are crucial factors. Buyers who can meet these requirements may find themselves in a less competitive market, making it easier to negotiate a favorable deal.

“Rates should be lower in the next 12 to 24 months,” said Ms. Cohn. Additionally, home buyers can consider refinancing their mortgage when rates decrease.

Ms. Cohn also recommends comparing rates from multiple lenders. “There are no magic tricks,” she said. “You need to shop around.”

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