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Last updated on February 3rd, 2021 at 11:07 am
Though the Federal Reserve does not have the ability to directly set mortgage rates, it does create the monetary policies that indirectly affect these rates.
The Fed’s policy rate applies to overnight loans between large financial institutions. The only way it directly influences mortgage rates is by serving as the basis for the prime rate.
Home equity lines of credit (HELOCs) are often based on the Prime Rate. However, there are many times that the mortgage rates have fallen after a rise in the fed rate and vice versa.
If the Feds want to boost the economy, it implements policies that help keep mortgage interest rates low.
The Fed Funds rate isn’t the only aspect of Fed policy. There are other policy tools that we find a much better correlation between Fed actions and movement in the bond market (which ultimately dictates mortgage rate movement).
Compared to other things, the Fed’s bond-buying programs have been had a bigger impact. When markets expect the Fed to start or maintain bond-buying, rates fall significantly.
When the Fed threatens to remove or decrease bond-buying, rates move higher.
Fed is currently buying a ton of bonds, both Treasuries and Mortgage-Backed-Securities (MBS are the ones that directly benefit the mortgage market).
Since the delayed Adverse Market Fee was re-implemented the lenders have increased the rate to borrowers of refinancing mortgages.
As such, homebuyers will find top tier rates that are still below 3% today whereas the average lender is back above 3% for refinances.
Apart from adverse market fees, the Feds might have a challenge pushing the rates lower.
The bond market may open the door for lenders to drop rates, but that only helps if lenders can handle the news business that lower rates would bring. How low could rates theoretically be under ideal circumstances?
As mortgage rates are based on the bond market, they are really only limited by how low certain bond yields can go.
Although the 10 year Treasury yield doesn’t actually dictate mortgage rates, it’s a popular benchmark and easier to understand compared to mortgage bond yields.
The 10yr has historically been lower than average 30 yr fixed mortgage rates by 1-3% with most of the post-mortgage-meltdown era seeing 1.5-2.0%.
Mortgage rates have a tendency to stretch the upper boundary of that range when rates are at all-time lows.
For instance, 30yr fixed rates never made it lower than 2.75%, and when they bottomed out, 10yr Treasury yields were around 0.50%. That’s a 2.25% spread between the two!
Treasury yields would need to remain at or under 0.50% for years in order for that spread to get as small as past precedent suggests it can be.
Apart from this simple comparison with Treasury yields, the mortgage market also has to consider the structure of its own bonds.
Specifically, investors need to be actively trading mortgage bonds that don’t yet exist in order for rates to get appreciably lower than 2.25%.
They usually wait to do so until the bond market leaves them no other choice. The inference is while rates could indeed move lower in the future, the improvements will be harder and harder as we approach the low 2% range.
Moving any lower from there would take a significant amount of time.
Reference Source: Mortgage News Daily
