A swift rise in mortgage rates is threatening to undermine the already-rickety real estate market and toss sand into the gears of Uncle Sam's plans to rescue the economy. Beginning last fall, the Federal Reserve rolled out a series of initiatives--such as the purchase of Fannie Mae and Freddie Mac mortgage-backed securities and long-term treasury bonds--that worked to drive mortgage rates down to all-time lows. Federal officials hoped that by pushing the cost of purchasing a home artificially lower, they could lure more buyers into the market to gobble up the massive supply of unsold homes. Meanwhile, lower mortgage rates could also enable scores of homeowners to lower their monthly payments by refinancing. That, in turn, would free up cash to be pumped back into the economy. For some time, the mortgage market acted accordingly, with rates of less than 5 percent triggering a flood of refinancing applications. But last week, rates surged, a development that could create all sorts of headaches for federal officials, consumers, and the economy as a whole.
Here are five things you need to know about the surge in mortgage rates:
1. The jump: Thirty-year fixed mortgage rates had been holding in the 5 percent range since mid March, averaging 5.03 percent on Tuesday, May 26. But rates jumped in the following days, hitting an average of 5.44 percent on Thursday, May 28. By midday Monday, rates had fallen back a bit, to 5.36 percent, according to HSH.com.
2. Key Factors: Fixed mortgage rates have been pushed higher by a surge in 10-year Treasury note yields, which climbed to 3.67 percent on June 1 from 2.68 percent on April 1, according to Bloomberg news. (Fixed mortgage rates typically track the yields on 10-year Treasury notes.) A number of factors have worked to increase Treasury yields. Nascent optimism about the economy has made ultra-safe investments like Treasuries less appealing. "If you look at the broad aggregate of economic data, it's not great but it's better on balance," says Keith Gumbinger of HSH.com. "So the Treasury market especially is going to be moving away from those emergency and panic modes we've been in now for 6 months." In addition, concerns about deflation are giving way to worries about inflation, he says. However, the bulk of the pressure is coming from concerns about the massive amount of government debt needed to finance the Obama administration's huge bailout and stimulus programs.
3. Home purchase impact: It's important to remember that 30-year, fixed mortgage rates of 5.36 percent--heck, 5.5 percent--are still incredibly low by historic standards. Still, higher rates have the potential to force home prices lower to compensate for the higher purchasing costs. "If [the higher rates are] in place for a while it could have the effect of putting some additional pressure on home prices," Gumbinger says.
4. Refinancing impact: But the impact on the mortgage refinancing market could be more significant. Rates in the 5.5 percent range would evaporate roughly 65 percent of refinancing demand because the higher rates don't offer enough savings to make the transaction worthwhile for many consumers, says Mark Hanson, a managing director who handles real estate and finance research at the Field Check Group. "Why would you want to pay $5,000 to close a loan when you are saving $20 or $30 a month," he says. "It's just not enough." Even more concerning, many consumers have already filled out mortgage applications without locking in their mortgage rates because they expected rates to drift lower before closing. The recent spike in mortgage rates, however, has made many of these yet-to-be-closed, non-locked loans unsalvageable without a sharp drop in rates. "Of all the applications in, 60 to 70 percent are [not locked]," Hanson says. "Out of those, 75 percent are dead."
5. Federal response: Given how aggressively the federal government has moved to bring mortgage rates lower, it's possible that Uncle Sam will step in to the market again. "I expect some sort of intervention," Hanson says. Federal intervention could take any number of forms, including plans to beef up its already expansive mortgage-backed security or Treasury bond purchase program.
6. Rate outlook: Gumbinger says the recent spike reflects uncertainty about the broader economy. "We are at the portion of the economic game where you are going to get this kind of fits and starts arrangement," he says. "Things are rosy one minute, and then somebody is going to catch wind or something and we could run the other way." He says rates may revisit the 5 percent range in the coming months. "And if we do, know that that may be temporary as well," he says. "If you really want a five percent number or a high four [percent] number on your mortgage, you need to be prepared in this market to take advantage of it [when it presents itself.]"