How Interest Rates Affect the Housing Market 2024

Buying a Home in Blossom Valley on Mortgage RatesHow Interest Rates Affect the Housing Market

Mortgage loans come in two primary forms:

  1. Fixed Rate
  2. Adjustable Rate

Greg Smith of The Re/Max Collection had this to say about the many forms of mortgage rates:

"There are hybrid combinations and multiple derivatives of each. A basic understanding of interest rates and how the economy influences them determines the future course of interest rates, and how you can make a sound mortgage decision. These decisions include choosing between a fixed-rate mortgage and an adjustable-rate mortgage or deciding whether to refinance out of an ARM."

How are Interest Rates Determined?

The interest rate is the amount charged on top of the principal by a lender to a borrower for the use of assets. The interest rate charged by banks is determined by several factors, such as the state of the economy. Central banks tend to raise interest rates when inflation is high because higher interest rates increase the cost of debt, which discourages borrowing and slows consumer demand.

Fixed Interest Rate Mortgages

The interest rate on a fixed-rate mortgage is fixed for the life of the mortgage; however, on average, 30-year fixed-rate mortgages have a shorter lifespan, due to customers moving or refinancing their mortgages.

  • The Fed's Role 

The Federal Reserve (Fed) plays a large role in inflation expectations. This is because the bond market's perception of how well the Fed is controlling inflation through the administration of short-term interest rates determines longer-term interest rates, like the yield of the U.S. Treasury 10-year bond. The Fed sets current short-term interest rates, which the market interprets to determine long-term interest rates.

Adjustable-Rate Mortgages (ARMs)

The interest rate on an adjustable-rate mortgage (ARM) might change monthly, every six months, annually, or less often, depending on the terms of the mortgage. The interest rate will consist of an index value plus a margin. This is known as the fully indexed interest rate. It is usually rounded to one-eighth of a percentage point. The index variable, while the margin is fixed for the life of the mortgage.

  • Forecasting Changes 

If you are attempting to forecast interest rate changes on ARMs, look at the shape of the yield curve. The yield curve represents the yields on U.S. Treasury bonds with maturities from three months to 30 years. When the shape of the curve is flat or downward sloping, it means the market expects the Fed to keep short-term interest rates steady to move them lower. The steepness of the curve in either direction is an indication of how much the market expects the Fed to raise or lower short-term interest rates.

The Mortgage Production Line

The mortgage industry has three primary parts or businesses: the mortgage originator, the aggregator, and the investor.

  • The Mortgage Originator 

The mortgage originator is the lender. Lenders come in several forms, like credit unions and banks. Mortgage originators introduce, market, and sell loans to consumers and compete with each other based on the interest rates, fees, and service levels that they offer. Most mortgage originators do not "portfolio" loans. Instead, they often sell the mortgage into the secondary mortgage market.

  • The Aggregator 

The aggregator buys newly originated mortgages from other institutions. They are part of the secondary mortgage market and most of them are also mortgage originators. Aggregators pool many similar mortgages together to form mortgage-backed securities, a process known as securitization. An MBS is a bond backed by an underlying pool of mortgages. MBSs are sold to investors to determine the price that aggregators will pay for newly originated mortgages from other lenders and the interest rates that they offer to consumers.

  • The Investor 

There are plenty of investors in MBSs, including pension funds, mutual funds, banks, hedge funds, foreign governments, insurance companies, and government-sponsored enterprises. Investors try to maximize returns, frequently running relative value analyses between MBSs and other fixed-income investments such as corporate bonds.

How Rates Impact the Housing Market

Brian Alexander of Bob & Ronna Group had this to say about how rates impact the housing market:

"When interest rates are higher or increasing, the housing market slows down. When interest rates are going up, the cost of owning a home becomes more expensive due to the higher interest rate, which reduces demand. This demand reduction then results in a drop in home prices. When the Fed increases rates to slow down the economy, particularly in times of inflation, the above goal is what it's looking for, a reduction in consumer spending that results in a drop in prices. When interest rates drop, the cost of buying a house becomes cheaper, which increases the demand for housing. This increase in demand then slowly increases home prices."

Am I Better Off with a Fixed-Rate or Adjustable-Rate Mortgage?

Generally speaking, an ARM makes more sense when interest rates are high and expected to fall. Conversely, if predictable payments are important to you and interest rates are stable, or climbing a fixed-rate mortgage might be your best option. Popular methods to potentially gauge the future direction of interest rates include studying the yield curve and paying close attention to Fed monetary policy.

The Bottom Line

An understanding of what influences current and future fixed and adjustable mortgage rates can help you make financially sound mortgage decisions. It can inform your decision about choosing an ARM over a fixed-rate mortgage and help you decide when it makes sense to refinance out of an ARM. It's not always a good time to refinance out of your adjustable-rate mortgage before the interest rate rises further. Interest rates might rise further moving forward–or they might drop. Find out what your yield curve is doing. Let your professional Homeowner Experience Real Estate agent guide you in finding your dream home in Blossom Valley, CA today!

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