In the current real estate market, prospective homebuyers and sellers are highly concerned about the prevailing mortgage rates. This leads to two common queries for individuals who are considering buying a home for the first time or selling their existing property to find a better-suited residence: What factors contribute to the high mortgage rates, and when can we expect them to decrease?
To shed light on these inquiries, let's delve into the relevant context.
1. What Causes the High Mortgage Rates?
The dynamics of supply and demand for mortgage-backed securities (MBS) primarily determine the current mortgage rates, especially for the 30-year fixed-rate mortgage. As explained by Investopedia:
“Mortgage-backed securities (MBS) are investment products similar to bonds. Each MBS consists of a bundle of home loans and other real estate debt bought from the banks that issued them . . . The investor who buys a mortgage-backed security is essentially lending money to home buyers.”
Demand for MBS helps determine the spread between the 10-Year Treasury Yield and the 30-year fixed mortgage rate. Historically, the average spread between the two is 1.72 (see chart below):
As of last Friday morning, the mortgage rate reached 6.85%, resulting in a spread of 3.2%. This spread is approximately 1.5% higher than the typical average. If we were to bring the spread back to its historical norm, mortgage rates would hover around 5.37% (computed by adding the 3.65% 10-Year Treasury Yield to the 1.72% spread).
The significant deviation in spread is quite uncommon, as highlighted by George Ratiu, Chief Economist at Keeping Current Matters (KCM). According to him:
“The only times the spread approached or exceeded 300 basis points were during periods of high inflation or economic volatility, like those seen in the early 1980s or the Great Financial Crisis of 2008-09."
The graph provided below utilizes historical data to visually demonstrate this point, specifically highlighting the limited instances when the spread has surpassed 300 basis points or more:
The graph effectively illustrates how the spread has gradually decreased following each peak, implying that there is room for improvement in today's mortgage rates. Now, let's explore the factors contributing to the wider spread and the current high mortgage rates.
The demand for mortgage-backed securities (MBS) is significantly influenced by the perceived risks associated with investing in them. Presently, these risks are influenced by broader market conditions such as inflation concerns and the possibility of an impending recession. Additionally, the Federal Reserve's efforts to combat inflation through interest rate hikes, negative narratives about home prices in media headlines, and other factors contribute to the overall risk environment.
In essence, when the perceived risk is lower, the demand for MBS increases, leading to lower mortgage rates. Conversely, when there is higher perceived risk associated with MBS, the demand decreases, resulting in higher mortgage rates. Currently, the demand for MBS is low, thereby causing the mortgage rates to be high.
2. When Can We Expect Mortgage Rates to Decrease?
In a recent blog post, Odeta Kushi, Deputy Chief Economist at First American, provides insights into the anticipated timeframe for mortgage rates to decrease. According to Kushi:
“It’s reasonable to assume that the spread and, therefore, mortgage rates will retreat in the second half of the year if the Fed takes its foot off the monetary tightening pedal and provides investors with more certainty. However, it’s unlikely that the spread will return to its historical average of 170 basis points, as some risks are here to stay.”
The spread is expected to narrow as investor fear diminishes, which would lead to a moderation of mortgage rates as the year progresses. However, it is important to note that predicting mortgage rates with absolute certainty is challenging, and unforeseen factors may influence their trajectory.