There’s a lot of buzz in mortgage brokerage and securities communities about the Federal Reserve’s recent rate changes. What do these increases really mean for the frontline troops who help buyers obtain their homes?
In order to understand what it means for brokers when the Federal Reserve raises rates, we should first examine the Fed’s role in our economy.
The Federal Reserve is tasked with maintaining a healthy economy. Its mission is to manage growth and inflation, stabilize prices, and balance employment through its monetary policy (Federal Reserve Act of 1913). The Fed does not directly set mortgage rates, but its policy decisions trickle down through the economy to create an indirect effect.
One of the Fed’s policy tools is the federal funds rate: The rate banks lend reserve balances to other banks on an overnight basis. This rate has a tremendous impact on financial conditions throughout our economy.
Lenders use the federal funds rate to set the prime lending rate: The interest rate they charge their most creditworthy customers, which are mostly other banks. Borrowing banks use the prime rate to determine interest rates for their other products, like auto loans, credit cards, home equity loans, and – of course – mortgages.
Additionally, the Fed indirectly affects mortgage rates through another policy tool called open market operations. This is the Fed’s practice of buying and selling securities like bonds. When the Fed wants to target a higher federal funds rate, it absorbs money by selling off bonds.
When more bonds are available, prices fall, which means the bonds have a higher yield (return). When bond yields rise, the yield of mortgage-backed securities (securities traded on Wall Street secured by collections of mortgages) must also rise to compete for the same investors. Thus, mortgage rates have to rise to provide attractive returns.
Essentially, in an effort to maintain economic stability, the Fed’s policies create a ripple effect that spreads through the economy affecting nearly every market, including mortgage rates. When the Fed wants the economy to grow, its policies make it cheaper for borrowers to take out a mortgage. When the Fed wants to cool off the economy, mortgages become more expensive.
For years, the Fed has kept the federal funds rate as low as possible (0.25% to 0.75%) to stimulate growth. When loans are cheap, people borrow money to start and grow businesses. On September 26, 2018, the Fed raised the federal funds rate to 2.25% – the eighth rate increase since the financial crisis of 2008.
While it’s true that the Fed influences mortgage rates, it’s not the only influencer. In fact, it’s not even the strongest variable. The market – investors who trade mortgage-backed securities – play a far more influential role.The Fed influences mortgage rates, but it’s not the only influencer. In fact, it’s not even the strongest variable. Click To Tweet
If the Fed were the only factor, we’d see a clear linear correlation between the federal funds rate and mortgage rates. This isn’t the case. The following graph shows the federal funds rate (blue) compared against mortgage interest rates (green) over the last few decades.
Notice how in 2008 the Fed dropped the federal funds rate significantly, but mortgage rates continued their steady decline. Clearly mortgage rates are determined by other factors.
So what influences mortgage rates the strongest? Like all transactions, the market is pushed and pulled by buyers who are motivated by greed and sellers who are motivated by fear.
Buyers consider all the variables and come to the conclusion that a particular asset couldn’t possibly fall further in price. Sellers, having access to the same information, conclude that the asset in question couldn’t possibly rise in value. Both are convinced they alone made the right decision and the other party is misinformed. The market is made of observers who agree or disagree with either party and we only learn who was right at the end of the trading day.
This means that mortgage-backed securities and thus mortgage rates are determined by innumerable market variables. One must consider a wide array of financial, geopolitical, and cultural factors to predict the fluctuation of mortgage rates.
While the Fed’s rising rates only have a minor impact on mortgage rates themselves, they still have some effect on your business. Let’s discuss what rising rates could mean for you.
While fixed-rate mortgages are only affected indirectly by the Fed’s rising rates, adjustable-rate mortgages (ARMs) are tied more closely.
When the Fed sets a target for the federal funds rate, it affects LIBOR, the rate banks charge one another for short-term loans. LIBOR is one of the variables used to calculate adjustable-rate mortgages, so when LIBOR rises, so do ARMs.
If a homeowner’s ARM becomes too burdensome, they may seek to refinance into a new mortgage or modify their existing one. Since we expect interest rates to rise gradually over the next several years, a larger portion of your business may involve refinancing and loan modifications as borrowers seek to capture today’s better rates.
Andrew Prasky, an agent with RE/MAX Advantage Plus, points out that today’s first-time home buyers are highly price conscious. “The majority of today’s homebuyers are millennials looking to make their first step into homeownership,” he says. “Any small change in affordability, like rising mortgage rates, will more than likely delay their purchasing.”
While rising mortgage rates don’t prohibit buyers from purchasing homes, they can affect how much buyers can borrow. Reduced purchasing power means your customers will have fewer options (there is an affordable housing shortage, after all) in their preferred areas.
It also means you may not be able to qualify buyers for a large enough loan to purchase their favorite house. This is especially difficult (for you and the buyer) if they’ve already fallen in love with their dream home.
Your customers may feel pressured to buy a home before rates increase further, even if they aren’t emotionally ready for the new phase of their life or as financially prepared as they’d like to be. They may come to you with a heightened sense of anxiety.
This could translate into more questions, more requests for updates, and a greater need to be reassured, especially if they’re first-time home buyers. Consider how much service you provide and whether your changing customer requires a more personal touch than you normally offer.
As mortgages become more expensive and fewer buyers are willing or able to purchase homes, you’ll undoubtedly face more competition in your region. It’s smart to find a way to set yourself apart from the other brokers. Mortgages are basically commodity products after all, so you can’t compete on price, but you can compete with information.
We built the TrueCast MBS Forecasting tool to give discerning brokers and loan officers the tools they need to make them the go-to resource for their referral network. We want those who send you loan business to see you as the most knowledgeable and insightful resource available in the marketplace. Armed with the Market Alert suite of tools, you’ll see market cycles before they happen to help you manage your MBS asset risk.
Yes, the Federal Reserve will continue to raise its rate. And yes, this will have some effect on mortgage rates. But it’s not the only factor and certainly not the strongest.
As a broker, the best thing you can do is ignore the Fed. Focus on your customers. Ask them what they need from you in this changing market. Then equip yourself with tools that give you the best information. People will always buy houses, no matter how high the Fed raises rates.