It’s time to reaffirm some advice. That’s because on Wednesday we heard from the ultimate authority on interest rates in the U.S.: the Federal Reserve.
Now, technically, the Fed does not set mortgage rates—but that’s probably what most people believe, given the amount of news and hype surrounding its decisions.
The way it really works: The Federal Reserve sets the short-term rate policy, which governs what banks charge one another for short-term loans. Short-term rates are different from long-term rates, but they typically move in similar ways in times of change.
Longer-term rates usually move before the Fed acts. Mortgage rates, in particular, usually track to long-term bond rates like the 10-year U.S. Treasury note. Since the surprise outcome of the presidential election, mortgage rates have risen close to 60 basis points—more than twice the quarter-point increase that the Fed did on Wednesday. (One basis point is 0.01%.)
Even before the election, evidence was stacking up that the economy was picking up momentum. Now the financial markets are betting that inflation will be higher under the Trump administration’s fiscal policies. But the data-driven Fed hasn’t seen the inflation evidence that would justify a greater increase in short-term rates yet.
Emphasis on “yet.”
If you want to understand how the Fed affects mortgage rates, pay more attention to what the central bank says about the future rather than the policy rate changes it has already enacted.
The Fed expects the economy to hit its target level of inflation next year. As a result, it also expects to raise short-term rates three times, by a total of 75 basis points. In reality, rate moves could be less—but they also could be more.
That means rates like we’ve seen for most of the past five years are indeed history.
Hate those annoying radio ads screaming about refinancing while rates are in the 3% range? Well, relax. They’re history, too.
Mortgage rates will move higher before the Fed acts again, so if the Fed carries out its three planned hikes in 2017, we could come close to 5% on 30-year conforming rates before the end of next year. This is more than I have been expecting even as recently as last month. My, how quickly things have changed.
It’s time for a bit of harsh reality: The move toward 5% will not likely be smooth, gradual, or immediate. Instead, rates will likely jump in intervals, based on whatever new positive economic data emerge and also when we see actions from the new Trump administration on fiscal policy.
Since mortgage rates have already gone up more than the Fed’s increase, they will likely stay in this range for the next two months or so. That means we may see some day-to-day volatility but little consistent movement up from where rates ended on Wednesday (the average 30-year conforming rate was just under 4.2%).
But as the year progresses, rates are more likely to move. Mortgage rates are most likely to move in the month ahead of each key Fed policy meeting. The most important meetings are in March, June, September, and December—so home buyers, mark your calendars!
If you intend to buy this year and finance the purchase with a mortgage, acting sooner rather than later will cost you less.
On a typical median-price home with 20% down, the monthly principal and interest payment would be $978 at a rate of 4.2%. That same home at 4.5% would cost $35 more per month. If we reach 5%, that monthly payment goes up to $1,074, or almost $100 more per month than where it is now.