At the end of 2014, the Freddie Mac rate on 30-year fixed mortgages was around 3.85%, and almost all projections assumed a relatively slow rise in rates throughout 2015. The Fed had ended its massive bond-buying program in October and signaled that interest rates were likely to rise during 2015.
Fannie Mae, Freddie Mac, and the Mortgage Banker’s Association (MBA) all forecast 3.9% in Q1. Rates in Q4 were predicted to be at 4.2% (Fannie), 4.5% (Freddie, or 4.8% (MBA). The National Association of Realtors (NAR) assumed rates would be nearing 5% at the end of the year.
Now that we approach the end of Q1 2015, however, we see a different picture. Rates sank to 3.59% in February, and after a short rally to 3.86% rates have dropped again to 3.69% and seem to be headed back down. Why is the 30-year fixed rate staying stubbornly low, and could it rebound to meet the original year-end expectations?
Part of the answer is that, bond yields remain low, despite cessation of the Fed’s bond buying program. (The 10-year US Treasury note is at just below 2% as of this writing.) Bond yields decrease with higher demand, and the global downturn is making US Treasuries one of the best conservative investment deals by comparison. (Some European bonds currently have negative rates.) As a result, the demand for Treasury notes is still strong.
Low bond yields keep fixed mortgage interest rates low, as they are competing for the same investor base (through mortgage-backed securities). Normally, this should lead to an increased demand in the housing market as more people are able to purchase homes—and indeed, mortgage applications have jumped based on the last two weeks of declining rates, according to the MBA.
However, there is another issue with the current market—housing supply. According to NAR data, the housing supply is still running below a 5-month inventory nationally. With the jobless rate decreasing, more people may be in the market but there may not be enough starter homes to accommodate them. It seems that fewer homeowners are upgrading and high levels of personal debt may be keeping them from doing so.
Consider that over 10% of homes are still underwater (owing more on their mortgage than the home is worth) and 20% of all residential mortgages are at or below the 20% equity mark of a standard down payment. Along with tight credit and relatively flat wages, debt/supply concerns apply a drag on the housing market and maintain pressure to keep interest rates low.
The New York Times suggests that cheap oil is yet another indirect source of low interest rates that could endure into 2015. Lower-priced oil is causing serious harm to oil-producing economies, making them poorer global investments. Meanwhile, the corresponding low US inflation and strong dollar add to the appeal of US bonds.
Eventually all of these downward pressures on interest rates will reverse. The oil supply will drop and prices will rise, the economy will gain steam, and the Fed will raise rates and start bleeding bonds back into the market to slowly reduce the enormous bond holdings on its balance sheet.
However, all of these reversals will likely take some time. The global economic outlook may take even longer. In February Freddie Mac Deputy Chief Economist Leonard Kiefer reported that Freddie does not expect the global economy to improve markedly, and suggested that even if the Fed raises short-term rates, mortgage rates should not increase much. We agree, believing rates are likely to stay relatively low through the balance of 2015.
Although fixed mortgage interest rates are still near historic lows, we don’t see them rising to the point that they approach 5% by the end of the year per earlier predictions. The housing market is likely to pick up during the spring buying season but there are too many pressures keeping rates low —including the Fed’s delay of interest rate hikes and suggestions that the hikes will be small and controlled when they do arrive.
External issues of cheap oil, a short housing supply, and the distorted bond market are also likely to keep rates tempered through the majority of 2015 —but a spike in in Mid-East unrest could drive oil prices higher fast.
If you have the money, a decent credit score, and you find a home that you like amid the relatively slim inventory, this market is perfect for you. If you do buy, we suggest locking in the fixed rate unless you plan to stay in the house a relatively short time, because even if interest rates rise slowly it will be difficult to beat the long-term savings over an adjustable-rate mortgage (ARM).
While it’s smart for home shoppers to take advantage of today’s low interest rates, beware of overextending yourself by putting too little money down or buying too large of a house just because fixed rates are low. You have a bit more time to get your finances in order and take full advantage of good rates. Don’t be spooked into a bad deal from the mere threat of interest rate hikes.