Mortgage interest rates—at 3.59 percent for a 30-year fixed rate loan and 2.92 percent for a 15 year loan—are now at their lowest level since May 2014. Potential homebuyers in the last several years have been consistently hearing that mortgage interest rates are about to go up, but the downward trend of the last year and a half is unmistakable. The reasons are complex, and of course individual borrowers may not find precisely these rates when they shop. But we recently huddled with our HFPC colleagues to pool our thoughts about the major forces that are pushing mortgage interest rates down.
They fall into two broad categories: forces that affect the interest rate on Treasury securities (reasons 1-3) and those that affect the mortgage risk premium above the Treasury rate (reasons 4 and 5).
- Slow growth and turmoil abroad: Though Europe isn’t facing the kind of turmoil it saw in 2011, we are seeing several years of slow growth there and in Japan and a slowdown in China, albeit from a fast pace. And with major turmoil in the Middle East and Ukraine, the United States looks like a much safer place to put money, driving down rates on Treasury debt that in turn drive down mortgage interest rates.
- Upheaval in the oil market: The rapid drop in oil prices is generally good news for American consumers (if less positive for American oil producers), but it also signals a degree of uncertainty in the commodity markets. Again, the certainty of Treasuries is alluring when commodity prices fluctuate so wildly.
- The US economy is steadily improving: While eventually this recovery will result in higher interest rates, for now, the uncertainty premium that is normally reflected in higher interest rates for longer term debt is small, and reduced from a year ago.
- Low Treasury rates, low mortgage rates: Yields on 10-year Treasury securities are typically used to set mortgage rates. Ten-year Treasuries currently yield 1.88 percent, well below historical levels (See Chart: Mortgage Rates Closely Follow Treasury Yields)—although higher than rates in Europe, Japan and Canada. The spread of mortgages over Treasuries is a little under 2 percent, higher than it’s been since September 2012, although in line with historical spreads. But with Treasury rates so low, mortgage rates are also low.
- Reduced demand for mortgages: We and others have written about the tight credit box and other factors that have reduced the demand for mortgages. In fact, we estimate that each year about 1.2 million fewer mortgages are being originated than would have been the case if 2001 credit standards were in effect. While mortgage demand may be down for reasons other than requirements for better credit, if the mix of originated mortgages is less risky than it was in the pre-bubble years, the mortgage risk premium can be expected to be lower. Generally increasing housing values should also reduce the risk premium.
There certainly are forces pushing mortgage interest rates in the opposite direction, most notably the tapering of the Federal Reserve’s purchases of mortgage-backed securities (MBS). This reduces the demand for MBS, putting downward pressure on their price and upward pressure on MBS interest rates, which flow through to higher interest rates on the underlying mortgages. And, as we point out in our monthly Chartbook (page 20), guarantee fees on loans purchased by Fannie Mae and Freddie Mac have increased dramatically. But so far, these forces have not been sufficient to stop the downward trend in mortgage interest rates.
Of the five forces discussed, three—commodity turmoil, very low Treasury rates, and reduced demand for mortgages—are capable of fairly rapid turnarounds. So we should still expect higher interest rates, although none of our colleagues are ready to predict when. But it’s nice to know why we’ve got low rates now.