Last week, the Federal Reserve lowered the benchmark interest rate by 0.25 percentage points for the first time this year. Following that, the borrowing costs for credit cards, auto loans, and home equity lines of credit all saw a decrease, except for mortgage rates which still remain stubbornly high.
In fact, mortgage costs had briefly dropped due to market expectations, but as of Thursday, September 25th, the 30-year fixed-rate mortgage quickly rebounded, climbing back up to around 6.37%. Over the past three years, mortgage rates have consistently stayed above 6%.
So, what exactly is going on? Experts explain that while the Federal Reserve’s rates do impact your credit cards, personal loans, and auto loans, they are not the primary driving force behind mortgage rates.
Unlike adjustable-rate mortgages affected by the Fed’s rate changes, fixed-rate mortgages are closely tied to the 10-year U.S. Treasury bond yield.
When banks issue mortgage loans, they typically package them with other mortgages and sell them to investors in the form of bonds, with the interest paid by borrowers being the bond yield. The return rates on these bonds are referred to as yields. Due to higher risks associated with mortgage bonds, mortgage rates usually sit 1 to 2 percentage points higher than the 10-year U.S. bond yield.
Currently, this spread (the yield spread) is much higher than historical norms, exceeding 2%, which is a key reason why mortgage rates have consistently stayed above 6%.
Selma Hepp, Chief Economist at Cotality, a California-based information services company, explained to CNBC that the higher-than-normal yield spread is primarily due to two reasons:
Firstly, inflation remains “firm,” especially in the service and housing sectors. Overall inflation in August rose to 2.9% year-on-year, surpassing the Federal Reserve’s 2% target. With inflation eroding mortgage bond yields, investors are demanding higher returns.
Secondly, the Fed has reduced its purchases of mortgage-backed securities, leading to decreased market demand, causing bond prices to fall, yields to rise, and consequently pushing up mortgage rates.
Christopher Hodge, Chief Economist at Natixis CIB Americas, the French Foreign Trade Bank’s Americas branch, pointed out that the Fed predicts inflation may not fall to 2% until 2028, implying that the current trend may persist. “This increases long-term inflation expectations, thus boosting the premium requirements for mortgages.”
Fannie Mae’s latest forecast released on Tuesday, September 23rd, indicates that 30-year fixed mortgage rates are expected to remain above 6% in the coming year.