What the Past Can (and Can’t) Tell Us about Future Mortgage Interest Rates
If you’re a homeowner, or have been considering buying a home over the past year or so, you’re sure to have noticed mortgage rates are on the rise. Over the past year, the rate on a 30-year fixed rate mortgage has gone from 3.88% in July 2017 to 4.55% in July 2018, according to St. Louis Federal Reserve data.
Let’s put those numbers into perspective. If a borrower were to put 20% down on a $390,000 home and finance the remaining $312,000 with a 30-year fixed-rate mortgage at the average 3.88% rate in 2017, they would have had a monthly payment of about $1,468, excluding taxes, insurance or other costs besides principal and interest. Today, at 4.55%, a monthly payment on the same terms would be about $1,590. Today’s borrower would pay about $44,000 more in interest over the course of the loan, assuming the borrower didn’t make any extra payments.
Rates are rising now, but they have risen — and fallen — before. In October 1981, for example, mortgage rates peaked at 18.45%. Rising rates now don’t necessarily mean rates will go up forever, so it may not be best practice to rely on the past to predict the future.
Why are rates rising?
According to Tendayi Kapfidze, LendingTree’s chief economist, rising mortgage rates are the result of the economy’s steady improvement.
“Rates are rising because the economy is relatively strong,” said Kapfidze.
The economy has been showing a lot of improvement since the 2008 financial crisis, so the Federal Reserve has been raising the federal funds rate. When the funds rate rises, so do treasury bond yields.
The 10-year treasury bond yield acts as a benchmark for many other financial matters, like mortgage rates, and as an economic indicator. Mortgage rates correlate with the interest rate on government bonds, so when treasury bond yields rise, so do mortgage rates. However, because mortgages are riskier, the average rate is usually higher than the average yield on treasury bonds.
The Trump administration’s recent tax cuts provided a stimulus to economy, but may have helped push long-term interest rates up too.
“Because of the tax cut, the government is running a much bigger tax deficit and borrowing more money, which raises rates,” said Kapfidze. However, he adds, he doesn’t expect mortgage rates to reach the all-time highs they did in the ‘80s.
Looking back: Historical trends in mortgage rates
“Looking back, it looks like there are better times to buy than other times,” said Bill Emmons, lead economist with the Center for Household Financial Stability at the Federal Reserve Bank of St. Louis.
Emmons said, generally speaking, the best time to buy is when home prices are low and mortgage rates are low, which typically happens after a recession.
“It’s easy to say with 20/20 hindsight that people should have bought in 2012, but you may not have been in a position to buy and that’s the point of maximum fear and uncertainty,” said Emmons.“It’s easy for an economist to tell people that they should be aware of this cycle — that there are good times to buy, after the recession, and there are bad times to buy, close to the peak.”
The opposite, the worst time to buy, is when prices are high and mortgage rates are high, as buyers face a double whammy when both housing prices and financing rates have increased.
What can historic interest rates tell us about the future?
“I and many economists would say look at the data, look back at the last few decades, and yet mortgage rates are probably not going to be behaving in the future the way they did in the past,” said Emmons.
Emmons says he thinks we are possibly nearing a peak in housing prices, but this time long term rates (e.g. the real interest rate, inflation and wage growth) are low, and investors appear to believe they’re going to stay low in the future.
“All of those combined push long term rates down to create what looks like a fairly stable pattern in the U.S. and across other countries,” said Emmons.
Emmons expects low long term rates to keep mortgage rates at a new post-recession normal, between about 3% and 6% as a best guess.
Kapfidze advises to never use past mortgage rate performance to try to predict the future — “because past performance is not an indication of future performance.”
“History may repeat itself, but you can’t really tell when. That’s the question,” said Kapfidze. “Ultimately interest rates are a function of an investment product so you can’t really look at what rates have done in the past to try and ascertain what they are going to do in the future.”
Both economists told LendingTree it’s possible, though unlikely, for rates to climb back into the teens like they did in the 1980s.
Mortgage rates were low in the ‘50s and ‘60s, but they peaked in October 1981 at 18.45% after the worst recession prior to the Great Recession in 2008.
“Odds of a financial crisis leading to spike in interest rates are actually very slim,” said Kapfidze.
Takeaways for the average consumer
According to the Federal Housing Finance Agency, rising mortgage rates increase the overall cost of borrowing for those who finance part of their home purchase. The rise translates into a higher monthly mortgage payment for borrowers. Higher economic inflation overall is pushing home prices up, too. Rising home prices intersect with rising rates if you are financing your home.
“You kind of are in an unfortunate situation where both prices and rates are rising,” said Kapfidze. He says a homebuyer now is dealing with both reduced affordability and generally, a reduced size of the home their money is able to buy.
The average mortgage rate is just that — an average. Ultimately, each and every borrower gets their own rate from a wide range of rates available in the marketplace. The rate you ultimately are offered depends on the strategy of the lender and your individual financial and credit history. Your best defense against rising home prices is to make sure you are as prepared as possible to make a solid offer (and possibly a counter-offer).
“You may end up with a higher or lower rate depending on your actions, so you have some influence on the rate your receive,” said Kapfidze.
Today’s prospective homebuyer needs to do a little more planning to combat both a shortage in supply and the rising rate environment. Here are few things you can do to set yourself up for success in this environment:
When you are ready to shop for a loan, the best thing you can do to get the lowest rate possible is to shop around. Your goal is to compare as many offers as possible and ultimately choose the offer that gives you the most favorable terms for your budget.
Tools like LendingTree’s Mortgage Savings Tracker and Monthly Payment Calculator, as well as monthly mortgage offer reports, can help you get a sense of the mortgage rate you may be offered. When you’re ready, you can compare offers from multiple lenders for free using LendingTree.
Don’t just look at the rate that you’re offered when you’re comparing offers — you should also look at the fees that may ultimately increase the overall cost of borrowing if you accept the offer. In addition, watch for things like primary mortgage insurance and unnecessary administration fees.
Put down a larger down payment
Saving up a little more than you planned to put down can help you save money in interest in the long run — the general rule of thumb is a 20% down payment for the best rates. You can still qualify for a mortgage loan if you put down less than 20%, but the loan will carry more risk for the lender and drive up the rate to offset the risk; the opposite happens when you put more down.
Additionally, if you put down less than 20%, you may be required to pay for private mortgage insurance (PMI) which reduces risk to the lender but increases the total amount you pay for the home over time. PMI generally costs about 0.15% to 1.95% of the loan amount until the homeowner reaches 20% equity and can cancel the policy. Depending on the lender you use, PMI may be paid in a lump sum at closing or financed into your loan amount.
Improve your credit score
Borrowers with the best credit scores are most likely to qualify for the lowest interest rates. Work to improve your credit score as much as possible before you sit down with a loan officer to calculate your loan terms.
Lower your DTI
Your debt to income ratio — your total recurring monthly debt divided by your gross monthly income — is a figure lenders look to when determining your ability to handle another financial responsibility. The lower your DTI the more debt the lender may determine you are able to comfortably afford.
DTI is a significant factor in calculating the mortgage rate you are offered. To lower your DTI, pay down any debt responsibilities you currently have and make an effort to increase your income as possible.
The higher your income in relation to your debt, the higher the amount that you may be allowed to borrow. Rising prices mean you will generally pay more money for less house. If you can lower your DTI, you may be awarded a larger loan, if that’s what you need for the home size you would prefer. Additionally, having other valuable assets at the time you apply for a home loan may help improve chances of getting qualified for a loan at a lower rate.
Know the difference between a fixed-rate mortgage and an ARM
Prospective homebuyers in a rising interest rate environment need to make sure they understand the differences between a fixed rate mortgage and an adjustable rate mortgage, a spokesperson from the FHFA told LendingTree.
With a fixed rate mortgage, the interest rate you receive is fixed and your monthly mortgage payment will stay the same over the life of the loan. An adjustable rate mortgage (ARM), on the other hand, carries a variable interest rate, so your monthly mortgage payment may change as mortgage rates change with the market.
With an ARM, you may get a lower rate than you would on a fixed-rate mortgage at the time you borrow, but the rate will adjust to an unknown amount in a number of years set by your terms.
If you can, wait a year or so
“If they have the flexibility to wait a year or three years that could be very valuable,” Emmons said.
“There are signs in [financial] markets and other signs that maybe we are close to the peak and that is in a sense the worst time to buy,” said Emmons.
He adds the best time to buy is after the downturn, which usually comes after a peak, and if that recession hits you personally then you’re not going to be in the best shape if you stretch your budget to purchase a home at higher rates today.
Keep emotions out of it
Resist red herrings like mention of the mortgage interest deduction — many real estate agents or lenders may tell you the deduction offsets other factors such as rising interest rates or home prices. But Emmons said it likely won’t benefit most homebuyers, and therefore you shouldn’t consider it in making a home buying decision.
There is a low inventory of homes on the market, so you may be competing with other buyers, especially if you are looking at a lower priced home. In April 2018, sales for homes priced under $100,000 were 13% lower year-over-year and sales for homes valued between $100,000 and $250,000 were down 1%.
“Be willing to walk away. If it is starting to be uncomfortable and a stretch [for your budget], standard advice is to slow down,” said Emmons. “Don’t put yourself in a bad position because you love the fireplace.”