It may be hard to believe, but mortgages are almost the cheapest they have been at any time in American history. The average 30-year fixed-rate mortgage stood at 3.13% at the start of April 2021, and while this is a slight increase from the low of 2.65% recorded on January 6, it is actually lower than at any other time in history before the coronavirus hit in early 2020. In fact, mortgage rates never went below 5% until the global financial crisis in 2007-09 and double-digit rates were fairly common in the 1970s, ‘80s and early ‘90s.
So, how did we get to these record-low rates and is this situation likely to last? And what does this mean for purchasing or refinancing? Read on for the answers.
Before we begin, we need to clarify that the Federal Reserve doesn’t set mortgage interest rates, mortgage lenders do. However, the Federal Reserve heavily influences mortgage interest rates through its target interest rate (known as the federal funds rate), which it sets eight time each year (or more in times of emergency) based on the prevailing economic conditions.
The federal funds rate is the rate at which banks and other financial institutions lend money to one another overnight to comply with federal cash reserve requirements. These costs are passed on to consumers through interest rates on loans, including mortgages. When the federal funds rate goes down, as in times of negative economic outlook, mortgage rates tend to go down; when the federal funds rate goes up, as is generally the case in times of strong economic growth and high inflation, mortgage interest rates tend to go up.
The Fed’s target rate did actually fall throughout 2019, from 2.75% to 1.75%, bringing the average rate on a 30-year fixed-rate mortgage from a high of 4.51% at the start of that year to 3.74% by year’s end. However, it was the Fed’s two emergency rate cuts in March 2020 in response to the coronavirus, which brought the target rate down to 0.25%, that saw mortgage rates crash as low as 2.65% in 2020.
No one can predict with absolute certainty where mortgage interest rates will be six months, one year, or two years from now, but based on the Federal Reserve’s own pronouncements as well as forecasts from various experts, it looks like low – if not exactly record-low – interest rates are here to stay in the near-term. Rates may eventually climb; after all, they are near record lows, so there is more room to move up than there is to move down. However, a drastic rate increase is unlikely in 2021.
First, let’s look at the Federal Reserve’s own carefully worded forecasts. In its most recent interest rate decision in March 2021, the Fed indicated that any interest rate hike is unlikely before 2023.
Another indicator to watch is the 30-Day Fed Fund futures, which is a direct reflection of collective marketplace insight regarding the future course of the Fed’s interest rate policy. CME Group’s FedWatch tool, which analyzes the 30-Day Fed Fund futures for the probability of future rate increases or decreases, sees a 90.5% probability that the Fed’s target rate will remain unchanged through 2021 and only a 9.5% probability of a rate hike before the end of the year.
There are additional factors lenders look to when determining mortgage rates, such as the U.S. 10-year Treasury yield, which is also a reflection of investor sentiment about the economy. When yields go up, this reflects optimism and puts upward pressure on mortgage rates; when yields go down, this reflects pessimism and puts downward pressure on mortgage rates. The 10-year yield fell as low as 0.52% in August 2020, the lowest in its 234-year history, but had pushed back up to 1.675% by April 12, 2021. Some analysts are predicting it could rise to 1.8% to 2% by the end of this year, which could lead to a small but undramatic increase in mortgage interest rates.
If you’re planning on buying a home, then mortgage interest rates aren’t the only thing to take into consideration. You also need to consider home prices. Like mortgage interest rates, house prices are extremely difficult to predict, and even more so given the ongoing and unpredictable economic fallout from the coronavirus pandemic. Immediately after the pandemic began, many analysts were predicting huge falls in home values, and prices did appear to slow down for a while. However, due to various factors – including the low cost of mortgages – home prices are starting to rise again, with Zillow reporting a 9.9% increase in the 12 months to February 2021.
According to Black Knight, a data and analytics provider to the mortgage industry, it now takes 20% of the median household income to make monthly payments on an average-priced home – back to the 5-year average but still stronger than the 20-year average of 23.4%.
Looking ahead, Zillow is forecasting an 11.4% price increase in the 12 months to February 2022, a figure backed up by similar predictions from other analysts. In short, while interest rates may not go up too much, home prices could increase significantly, bringing housing affordability back toward the historical average.
The future is always uncertain, but you have the power to determine what you do in the present. If you’re currently in the market for a house, you have broadly two options:
- Lock in the near-record low rates on offer and buy now; or
- Hold your breath and pray for lower rates or lower home prices in the future.
Of course, when deciding whether to purchase, always take into account your own personal financial circumstances and do thorough research on the neighborhoods where you’re planning to purchase. What qualifies as a general trend across the country may not always apply in every case.
If you’re thinking about refinancing an existing mortgage, the record-low rates of 2020 may have disappeared but it’s not too late to lock in rates that are lower than the historical norm.
According to data from the Mortgage Bankers Association, refinancing applications were 20% lower in April 2021 than the same time the previous year but still much higher than in 2019. This make sense given that current mortgage interest rates are still lower than they were at any time in history before COVID-19 hit.
According to Black Knight, the number of American ‘refinance candidates’ (people with 720+ credit score and at least 20% home equity who could cut their current interest rate by at least 0.75% with a refi) stands at around 12 million people with mortgage interest rates at 3.13%.
If the average 30-year fixed-rate mortgage falls back to 3%, there could be as many as 19 million refinance candidates. But if mortgage rates climb back toward 4%, the number of refi candidates could fall to less than 7 million.
Nobody can say for certain what mortgage rates will look like in a few months, but the evidence suggests they might climb – but perhaps not too dramatically. However, with house prices soaring, now is a good time to lock in a low rate on your mortgage.