What is causing Mortgage Rates to spike and what's the outlook?

Mortgage rates have gone up every single week for last 5 weeks - now up ~.75%. (Get the mortgage rate update in this post).  It all started with Fed announcing Quantitative Easing 2. The big question is why so sudden and why so steep! There are several possible reasons:

  • Markets are increasingly more optimistic that 2011 economic growth will be stronger than what had been expected. Expectations until a couple of weeks ago were for GDP growth in 2011 to be 3.0%, now the consensus is for growth to be at 4.0% and a decline in the unemployment rate from the present 9.8% to 8.7% by the end of 2011.
  • The extension of the Bush tax cuts, the 2.0% cut in workers contribution to social security will put more cash in consumers' pockets.
  • Also driving rates higher, the end of safety moves generated by issues in Europe and in the US and Congress's unwillingness to cut federal spending. The $858B tax cut bill now moving through Congress is yet one more Christmas tree filled with earmarks (pork), politicians can't do anything that doesn't end up in more unnecessary spending. The fiscal budget bill also moving through Congress is hung with earmarks driven by Democrats and with not a lot of strong resistance from Republicans.

Outlook for Mortgage Rates:

Since Real Estate recovery is key to overall economic recovery, you might think that the Fed won't allow the rates to continuously go up. But surprising as it may sound, the Fed doesn't directly control mortgage rates.  Ben Bernanke & Co. directly control the Federal Funds rate -- i.e,.  the rate at which banks lend to one another on an overnight basis and that serves as a benchmark for short-term credit. But the longer the term of the debt, the less direct control the Fed has over the interest rate, and the more other factors and emotions come into play. That's where the factors mentioned above are taking over and hence the sudden rise in rates.

In a nutshell, Investors in fixed income are not willing to hold low rate treasuries with the deficit increasing, inflation concerns, and a better economic outlook. Interest rates climbing as rapidly as they have is confirmation that the end of inordinate low rates is over. Having said that, we are still under 5% for long term fixed rates and under 4% for ARM (variable rate mortgages). These are some of the lowest mortgage rates we have seen in our history.

For the Real Estate industry, it could even turn out to be a good thing; since most potential home buyers who have been sitting on the fence could now decide to finally make a home purchase because of the fear of rates going further up.

One thing constant about mortgage rates is - it never remains constant. But I will be sure to update you when the change is worth talking about. If you are someone who would like to remain updated more frequently, follow me on Twitter where I tweet live about changes to Mortgage Backed Securities and hence the mortgage rates.

Contributed by Shashank Shekhar, a San Jose, CA based Mortgage Broker and Direct Lender. This post was originally written on his widely acclaimed mortgage blog.


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