Mortgage rates are something that on the surface looks basic but is actually quite complicated – similar to how a baseball pitch looks simple – throw the ball, and the batter hits or misses – when, in fact, it is a complex combination of mechanics, grip, delivery, spin, wind speed and more. A mortgage rate is no different, which is an important thing to remember in the face of the Federal Reserve’s (“Fed’s”) recent prime rate hike (which is not the same as a mortgage rate – more on that in a minute).
Since getting a mortgage is more often than not a critical component of buying a house, it’s important for most home buyers to have a better understanding of what goes into the rates that just the fact that they help dictate how much house you can afford.
From a purely financial standpoint, two of the biggest factors that impact mortgage rates are the economy and inflation.
The Fed adjusts the prime rate based on its study of the economy and its direction. In the last year, the Fed has raised the prime rate twice, both times because of what are called “leading indicators” (jobs, manufacturing and others). They have shown a strengthening economy – which is a good thing. However, a strengthening economy can lead to inflation – an increase in how much things cost. The Fed will raise the rate when it sees that people are spending more and feels that it needs to ensure that, to oversimplify, individuals don’t overspend and cause a financial crisis (see “Recent History: Housing Bubble, Internet Bubble, etc.”). Conversely, the Fed will lower the prime rate when it indicators appear to say that people need some help in their ability to make purchases, and therefore boost the economy.
Something to keep in mind is that the Fed’s moves alone, up or down, don’t tell the whole story. As evidenced after both of its recent prime rate raises the mortgage market essentially shrugged and said, “Yeah? So?” One big reason is that the markets, all of them, factor in moves by the Fed long before they occur. For instance, the stock market behaves in much the same way when it comes to investments – what you see today is usually baked in long before it occurs (except for the impact of major world events – which leads us to our next point).
A discussion of the impact of investor and stock market behavior is an entire article (or articles) on its own. But even the casual watcher of financial events will see that world events can send the financial markets in either direction at beakneck speed. The same can be said for the Fed. Back in 2015 the Fed decided not to raise interest rates even though the economic picture appeared to be clearing. Why? Among other things, political unrest in the Ukraine and the Middle East, as well as financial crises in Greece and China gave the Fed pause because it was concerned about “contagion” – the potential for those issues to affect our economy.
Those kinds of world events can and do affect the broader markets in general and mortgage rates in specific – as well as events at home. Recently, when Congress failed to pass its healthcare reform, a stock market that had been bullish suddenly dug in its hooves, leading to all of the major stock indices having their worst week since 2011. And what happened to mortgage rates? Lenders awoke on Monday morning to the lowest levels in more than a month (they’ve since risen). This gets into a larger discussion, again, of investor confidence and how investing in general can affect mortgage rates (just another piece of the puzzle).
So what does that mean to you as a buyer? You can’t predict, alter or drive domestic or world events, but you are the master or mistress of your housing destiny. Understanding what goes into your mortgage rate helps to make you a more informed consumer – and it never hurts to learn as much as you can about all of the things that impact your financial life. But the best advice is to follow your plan and lean on the guidance of a trusted lender – it’s their job to make sense out of a sometimes confusing financial world and help you get the right mortgage you need for the house you want.