More than a year ago, mortgage interest rates shot up when the Federal Reserve signaled it might scale back a program designed to pump money into the ailing economy.
On Wednesday, the Fed said that program will end this month.
But nobody expects much to happen right away to mortgage rates, which are currently near historic lows. The market saw the end coming, and planned accordingly, many housing experts said. If there are wild fluctuations in mortgage interest rates any time soon, it’s not likely to be tied to the Fed’s announcement today.
The Mortgage Bankers Association expects the average rate on a 30-year, fixed rate mortgage to rise slowly to 5.1 percent by the end of 2015 -- a full percentage point higher than where it was last week -- as the U.S. economy grows and the job market improves. (Generally, strong economic performance pushes mortgage rates up.) If not for the economic and political turmoil that's erupted in other parts of the world, the forecasts for mortgage rates would probably be even higher.
"In our forecast, we're assuming that the global issues remain at a simmer," said Michael Fratantoni, the MBA's chief economist. "If they were to come to a full boil, rates would stay lower for longer."
Whether that would make a huge difference in the housing market going forward is unclear. The low mortgage rates of the past year have not helped pry home buyers off the sidelines. Last week, the number of people applying for a home loan fell to its lowest level since February, the MBA reported Wednesday. “The job market is far more important than rates when it comes to home buying,” Fratantoni said.
Still, the Fed’s program – also known as “quantitative easing” – was a useful tool when it was needed most, research shows. It was launched late into the 2008 financial crisis as part of a push to stimulate the economy. The Fed then began buying a sizable chunk of treasuries and mortgage-backed securities issued by firms such as Fannie Mae and Freddie Mac.
The purchases immediately pushed mortgage rates reliably below the 6 percent mark for the first time in years. The central bank then conducted two more rounds of purchases that pushed rates down even further, causing them to fall to some of the lowest levels ever recorded.
A recent study found that when the interest rates plummeted, homeowners with adjustable-rate mortgages ended up saving $150 per month on average, which dramatically reduced their chances of falling behind on their loans and led to more consumer spending – on cars in particular.
But alas, in June 2013, the Fed signaled it would soon trim its purchases. That’s when the markets got spooked, fearing that the private sector would not be able to absorb the supply of mortgage-backed securities. Rates started rising, peaking at 4.58 percent on a 30-year, fixed rate mortgage in August of that year -- nearly a full percentage point higher than a year earlier, according to Freddie Mac.
As it turns out, the fears were unwarranted. The higher rates discouraged people from refinancing or buying homes, so the volume of mortgage-backed securities shrank. In the meantime, the economy improved. The Fed began scaling back its purchases in January, and economists began predicting rates would rise further.
But optimism about the economy didn’t last, and rates didn’t move up. Earlier this year, the U.S. economy contracted and the global economy stumbled. All of this helped keep mortgage rates low. The rates took a noticeable dip Oct. 15 when the stock market plunged. Investors were reacting to more global economic instability and the ebola outbreak. They started plowing their money into relatively safe U.S. bonds.
When demand for long-term bonds is high, the yield falls on long-term investments, which translates into lower rates on 30-year, fixed rate mortgages. Interest rates generally fall when the stock market does poorly.
But the Fed has remained on its steady path of pulling back its purchases. The central bank was buying $85 billion a month starting in the fall of 2012, almost evenly split between treasuries and mortgage backed securities. It began reducing the purchases by $5 billion a month in January 2014.
“The end of this program has been well-planned,” said David Crowe, chief economist at the National Association of Homebuilders. “It’s been pretty clear what the Fed would be doing, and the market has taken that into account.”
Now attention is turning to how long the Fed will hold onto the $1.7 trillion in mortgage-backed securities it has purchased. The central bank has said it does not plan to sell off these securities. Instead, it will maintain the portfolio at its current size for now by replacing loans that are paid off with new ones.
“There’s a long running debate as to how quantitative easing impacts mortgage rates,” said Mark Zandi, chief economist at Moody’s Analytics. “Is it through the purchases themselves or through the holdings it has on its balance sheet?”
The Fed said it will stop maintaining its portfolio of mortgage backed securities sometime after it raises short term interest rates. Long term rates, including mortgage rates, generally climb when the Fed raises short-term rates. It's not clear when the Fed will boost the short-term rates. But when it does, the Fed will simply let the mortgage-backed securities it is holding mature. Zandi predicts it will take a decade for those holdings to fade away.