GRAND RAPIDS — What’s going to happen to mortgage interest rates in the coming months? The trend appears upward — at least for the short term.
When the Federal Reserve increased the federal funds rate by 25 basis points to 2 percent in November — the fourth quarter-point hike this year — most banks followed suit and increased their prime rates for short-term commercial loans by a corresponding amount, as is typically the case.
The Fed “manages” the federal funds rate — the interest rate banks charge each other on overnight loans — to influence the economy and control inflation.
“Over a longer period of time — a few months or so — the federal fund rate and mortgage rates tend to track together,” said Mike Manica, president of United Bank of Michigan. “So if the Federal Reserve is raising rates, ultimately your longer term or intermediate term rates go up also.”
Although the fed rate influences mortgage interest rates, they’re more directly affected by other factors.
There’s a short end and a long end to the yield curve, and mortgage rates are driven more on the long end of the yield curve because they are longer-term loans, said David Ide, senior vice president of Standard Federal Bank. In that sense, mortgage rates are not directly influenced by the federal funds rate.
In a perverse way, the fed fund rate rising can actually be helpful for keeping mortgage rates low, Ide said.
“The things that drive along into the yield curve are inflation expectations. As the Fed continues to signal that it’s going to be vigilant in bringing rates back to a more normal level, that signals to the market that it’s going to be vigilant in seeing that inflation is not reignited. That helps to keep rates at the long end of yield curve low.”
The mortgage market is much more attuned to the 10-year Treasury note, and that rate is primarily a capital supply-demand marketplace, Manica explained.
“That’s what your mortgage rates are generally tied to. You can track mortgage rates on the 10-year Treasury.”
The yield on 10-year Treasury bonds is often used as an index for 30-year, fixed rate mortgage loans, and the one-year Treasury bond is usually used as an index for adjustable rate mortgages.
The Treasury market is a lot more volatile, said Brent Beeman, CFO of Huntington Bank, West Michigan.
“If you look at it from day to day, it will swing,” he said.
“What the Treasury market does is actually digest the data that comes out — the consumer price index and all types of economic factors like unemployment rates — and will either respond to it or it won’t, but usually its response is to go up or down based on whether the data is good or bad.”
What the Fed does with the federal fund rate has some impact on mortgage rates because it sends a message to the market about what the economy is doing, Beeman said, but mortgage rate movement hinges on what the Treasuries do.
The rate that lenders charge, he explained, is basically what they can sell off the mortgages for in the secondary market, and consumers aren’t going to see a whole lot of difference in mortgage rates between different lenders.
The economy is getting stronger and interest rates go up on the strength of the economy, Beeman noted
“We believe interest rates are going to increase gradually over time,” he remarked. “What the Fed is trying to do is make certain we have a fairly good level of economic growth and, at the same time, a reasonable level of inflation. I think it’s a good thing that rates are going up because that means the economy is growing stronger.”
Beeman reminds consumers that when it looks like rates are going to go up, it’s always best to lock in the rate as soon as possible.
Mortgage rates typically go hand-in-hand with economic cycles, falling when loan demand is low — because of high inflation and high unemployment, for instance — and climbing when demand is higher, such as periods of high employment and healthy GDP growth.
However, that didn’t exactly hold true over the past four years as the Fed loosened monetary policy; mortgage rates dipped to historically low levels and demand for mortgage loans and refinancing boomed.
“That has been a sector of the economy that has really helped the U.S. economy get through some very difficult periods of manufacturing job losses, technology bubbles and the like,” Manica observed.
The low-rate mortgage environment boosted home buying, building and remodeling and proved to be the economy’s “shining star.”
Ide pointed out that the mortgage market has changed somewhat in the past couple of years. Lenders are seeing more and more borrowers migrate to adjustable rate mortgage products, specifically some of the hybrid ARM products, he said.
Home prices have escalated, he explained, and in some cases borrowers were moving to those products because that’s how they could afford the house, plus the rates were cheaper relative to the longer-term fixed rates.
With the Fed move, lenders are now seeing movement in the shorter end of the yield curve and that part of the curve drives some of the shorter-term mortgage rates, Ide observed. Borrowers can expect to see higher rates on some of those products, which will make them less attractive relative to traditional, fixed rate mortgage products, he added.
“Rates are still relatively low, but longer term, if the Fed were to move real aggressively in response to a strengthening economy, it raises questions about the ability of borrowers to service that debt when rates start adjusting at higher levels,” Ide said. “That’s a pretty important issue.”
When the economy is performing better and more people are employed, Manica said a little inflation often follows, and that tends to push mortgage rates up a little higher.
Manica said it appears the Fed has decided the economy is strong enough to begin moving rates up from the very accommodative stance where they’ve been.
“Along with the jobs report that shows a lot more people are working and with some hint of inflation — I think most prognosticators would believe that we’re going to see a slow rise in interest rates, certainly through next year.”