Only a couple of months ago, exceptionally low mortgage rates were one of the few optimistic landmarks in an otherwise bleak economic outlook. After the Federal Reserve unveiled a series of initiatives beginning last fall—such as purchasing Fannie Mae and Freddie Mac mortgage-backed securities and long-term treasury bonds—mortgage rates plunged to all-time lows. In early April, with 30-year fixed mortgage rates dropping to less than 5 percent, President Barack Obama beseeched homeowners everywhere to capitalize on the development by refinancing their mortgages. "The main message we want to send today is there are 7 to 9 million people across the country who right now could be taking advantage of lower mortgage rates," the president said, according to the Associated Press. "That is money in their pocket."
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But in recent weeks, mortgage rates have spiked. And today, they represent perhaps the most menacing obstacle to the federal government's efforts to revive the housing market and pull the economy out of its devastating rut. Rates have surged from 5.03 percent on May 26 to 5.79 percent on June 10, according to HSH.com, as mounting concerns over government spending and potential inflation have sent yields on 10-year treasury notes—which fixed mortgage rates typically track—barreling towards 4 percent. In just 2½ weeks, much of the Federal Reserve's work to drive rates lower has unraveled.
Higher mortgage rates undercut the recovery in a number of ways. First, they drive housing costs up, which limits buyer demand and threatens to drag already falling home prices even lower (although even at 5.79 percent, mortgage rates are still phenomenally low from a historical perspective). But it's the refinancing market that really gets hammered since higher rates destroy many homeowners' incentives to restructure their mortgages. Last week, spiking rates sent refinancing applications plummeting to their lowest level since November 2008, according to Bloomberg News. That means fewer Americans will be able to reduce their mortgage bills, preventing monthly savings that could have enabled them to pump more cash back into the economy. "Whatever you hear in the media about the potential negative implications of 6 percent conforming rates on the mortgage refi arena ... multiply it many times over," wrote Mark Hanson, a managing director who handles real estate and finance research at the Field Check Group, in a report yesterday. At the same time, banks—which still face a long road back to health—may see less revenue from this business line that helped them fatten profits in the first quarter.
Despite the current surge, some experts say there is reason to believe that mortgage rates could reverse course in the near future, returning to the more attractive levels of a few weeks back. "It's not real logical that mortgage rates are climbing—it's not like we are out of the recession or the economy has changed dramatically," says Guy Cecala, publisher of the trade publication Inside Mortgage Finance . "I don't think it's unheard of to say that sometime this summer we are going to see rates back below 5 percent."
Here are five factors that could drive mortgage rates lower in the near future:
1. Government i ntervention: In an effort to reduce rates, the Federal Reserve could always intervene again. "There is still a reasonable probability that the Fed will raise or significantly increase its commitment to buy treasury bonds and Fannie and Freddie bonds," says Mark Zandi, the chief economist at Moody's Economy.com. Such an intervention could certainly push rates down in the short term, but it could also backfire by fueling additional concerns about inflation. And if an expanded effort fails to keep mortgage rates lower, the Fed could find itself in a serious lurch. Still, Zandi says it's a risk that the Fed may have to take. "The risk of them not doing it is greater than the risk of them doing it," he says.
2. Data d ive: The relative improvement of recent economic data—which has fueled optimism for a recovery—is also partly responsible for the rise in mortgage rates. "The data is not good yet, but it is at least less bad," says Richard Moody, the chief economist at Forward Capital. Over the fall and winter, 10-year treasury yields were depressed by the economic panic that boosted demand for ultrasafe government debt. But a growing sense of confidence has directed many investors to more risky assets like stocks instead of treasury bonds. As a result, treasury yields have increased, pushing mortgage rates higher. However, if future economic reports come in weaker than expected, investors could return to the safety of treasury bonds. "For example, next month's job numbers are probably going to be measurably worse than the last one," Zandi says, adding "and that will be a reminder" that the economy's troubles are not over yet.
3. Stock m arket t umble: Since early March, the stock market has been in the swings of a surprisingly resilient rally, with the Dow Jones industrial average up roughly 33 percent over this period. But should stocks start tanking again, mortgage rates could retreat, Cecala says. "One thing that people don't factor in is when the stock market tends to do better, mortgage rates tend to go up," he says. "[If] the rally stalls—or if we have one or two days where we have a 100-point drop or more—you are going to see treasury rates and mortgage rates decline quickly. Investors will flock to the bond market."
4. Exit s trategy: Much of the upward pressure on 10-year treasury yields—and therefore mortgage rates—has been fueled by concerns about the mountain of government debt required to finance Uncle Sam's massive bailout and stimulus programs. But Keith Gumbinger of HSH.com argues that if the Obama administration would outline a potential exit strategy for these commitments—perhaps indicating that not all of the funds would be deployed should the economy revive sooner than expected—the upward pressure on treasury yields could moderate. "If there was any expression of when these supports would be pulled, under what terms and conditions they would be pulled, and how we would rein in these really jaw-dropping deficits going forward, I think you would find that the markets would react positively to that," he says.
5. Competition: Cecala also notes that an absence of competition in the mortgage market has enabled lenders to expand the difference or "spread" between the yield on 10-year treasury notes and mortgage rates. "Historically, the spreads between the 10-year treasury [yields] and 30-year mortgage [rates] are unusually large now," he says. "That partly reflects the fact that we don't have a competitive mortgage market." But with refinancing applications dropping, Cecala says competition in the mortgage market could heat up, with lenders reducing these spreads to attract more customers. "The mortgage industry has spent a good part of this year trying to ramp up their mortgage operations to take advantage of the [refinancing] boom," he says. "I don't think they want that to go away, and they can be more competitive on rates than they have been."