Mortgage rates may be at historic lows, but they've still jumped around somewhat in recent months, perplexing Americans mulling a home purchase this spring. It's not always easy to pinpoint the cause of interest rate volatility, but much of it has to do with fickle capital markets, supply-and-demand dynamics, and even turmoil abroad.
Outside investors play a key role in the mortgage marketplace, and demand for mortgage-backed securities heavily influences the direction of interest rates. When you take out a home loan from a bank, it's unlikely that that same institution receives your payments. Instead, your loan is pooled with other mortgages—a process called securitization—to create mortgage-backed securities. Investors then buy mortgage-backed securities as part of their investment portfolio.
"It's hard to say exactly how much investor reaction you get to any specific event," says Keith Gumbinger, vice president of mortgage information website HSH.com. "The kind of event matters very much as to the type of response you get."
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If you're getting serious about buying a home this spring, here are a few things besides your credit score that could impact the rate you get on your home loan:
Global events. One of the most important elements driving mortgage rates is investor confidence. In general, natural disasters or political and economic instability undermine that confidence and make the investors who supply the capital needed for home loans nervous.
For example, the recent earthquake, tsunami, and nuclear crisis in Japan raised a host of questions among investors, not only about the future of the Japanese economy, but how an economic slowdown there could potentially impact growth in the United States. Many times, these generalized concerns cause a "flight to quality," experts say, in which anxious investors move money out of riskier asset classes such as stocks and into those with greater perceived safety—bonds such as mortgage-backed securities and U.S. treasuries.
Heightened demand for these "safer" investments drives down interest rates, which ultimately benefits mortgage applicants and homeowners looking to refinance existing home loans.
"When there's trouble afoot elsewhere, that almost always accrues to the benefit to mortgage borrowers," Gumbinger says. "Money rushes in, which drives down interest rates. Those dips can be short-lived, but sometimes those dips can be a little more durable, so borrowers get to enjoy slightly lower interest rates."
Domestic issues and policies. While inflation hasn't "officially" ramped up in the U.S. yet—core inflation, which strips out jumps in energy and food prices, rose just 0.1 percent in March—the prospect of higher prices is still on the minds of Americans and investors alike. Fixed-income investments such as bonds and mortgage-backed securities are particularly vulnerable to spikes in inflation, because it erodes the value of existing coupon payments and usually increases interest rates. Not good news for borrowers.
"Inflation erodes the purchasing power of a fixed investment like treasuries and investors will demand to be more highly compensated to invest," says Cameron Findlay, chief economist at mortgage information website LendingTree. "That will be expected to translate into rising rates for borrowers."
However, despite the starring role mortgages played in the financial sector meltdown in 2008, perceived credit risk has abated somewhat, which has helped keep interest rates on mortgages as low as they have been in recent months.
"After the mortgage meltdown, demand for mortgage-backed securities decreased relative to treasuries. There was more yield for mortgage-backed securities relative to treasuries because the risks were higher," says Dan Malouff, pricing executive for Bank of America Home Loans. "As home prices stabilized, concerns around that risk have been decreasing and that's helping keep rates low."
Experts cite the high level of public debt as another potential mortgage-rate mover. Interest rates on U.S. Treasury bonds—bonds the federal government needs to finance day-to-day operations and service existing debt—serve as the benchmark for many consumer loan products, including mortgages. As interest rates inch up to attract treasury investors, so will rates for consumers looking to take out loans.
The fate of Fannie and Freddie. The financial sector meltdown has had many lasting effects, not least of all a major disruption in the mortgage marketplace. According to Gumbinger, the federal government or quasi-governmental entities now back most mortgages today, which has provided an extra level of security for investors. That sense of security and confidence has helped keep rates low for borrowers.
"We don't have a real robust secondary market going on where there are a lot of private mortgages. What you have is investors investing in Ginnie Mae backed by the FHA or Fannie or Freddie," Gumbinger says. "These are well-engineered, mortgage-backed securities and they do have some guarantees against loss."
"Fannie and Freddie have the full faith and credit of the US government," Gumbinger adds. "Absent that guarantee, would interest rates be a lot higher? Oh yeah, they would."
Frank Nothaft, vice president and chief economist at Freddie Mac, agrees. "Rates are a lot lower than they would otherwise be because of FHA, Freddie Mac, and Fannie Mae," he says. "These programs help us have lower borrowing costs, which enables us to provide lower rates for mortgages."
However, with uncertainty facing the ultimate role government-sponsored enterprises will have in the mortgage marketplace going forward, there is a chance investors could demand higher interest rates in the future. That means would-be home buyers might be faced with higher mortgage rates in addition to the stricter credit standards and higher down payment requirements some are already facing.
"By having Fannie Freddie buying all originations, that has synthetically driven rates lower," says Findlay. "Removing the government-sponsored enterprises from the market and having private labels step in, the rates offered to consumers can be expected to rise anywhere from 50 to 80 basis points."
Luckily, experts say that for the time being, mortgage rates should remain relatively low and stable. "It usually takes a major economic event [to see a large move in mortgage rates]," Malouff says. "The market has settled in and there hasn't been any major shift in the economy such as inflation or deflation. There seems to be somewhat of a balance right now that is keeping the rates in that range."