As of May 22, mortgage rates had fallen for four consecutive weeks, creating some attractive opportunities for prospective buyers who want to minimize their interest costs, and for current homeowners who want to refinance a mortgage. There is just one warning to go with this good news: do not sleep on this opportunity too long, because mortgage rates seem unlikely to stay this low.
The reason behind this warning is simple: recently, mortgage rates and inflation have been heading in opposite directions. That is not a trend that can be sustained for long.
Mortgage Rates Lose Their Inflation Cushion
If mortgage lenders earned a mortgage rate that merely matched the rate of inflation, they would lose money with every loan. So, it is a given that mortgage lenders need a cushion over the rate of inflation, to cover expenses and default risk and to turn a profit.
The tricky part is that mortgage terms are commonly 30 years in this country, rates are often fixed, and nobody knows what the inflation rate is going to be over the next three decades. However, expectations about inflation are heavily influenced by recent experience. The experience based on the most recent inflation numbers may be telling lenders that they need to bump up their inflation cushions.
Here are the numbers:
- Over the past ten years, 30-year fixed mortgage rates have averaged 2.8 percent over the trailing 12-month rate of inflation. Think of that as the normal inflation cushion for that period. This is based on mortgage data from the Federal Reserve and inflation data from the Bureau of Labor Statistics.
- Last month, the inflation cushion dropped below that norm, as 30-year mortgage rates sank as inflation rose. As recently as February, 30-year fixed mortgage rates were 3.2 percent ahead of the inflation rate. By April, this cushion had shrunk to 2.34 percent.
- The trend is even more alarming if you assume the most recent inflation trend will continue rather than looking at inflation over the past 12 months. 30-year fixed mortgage rates are only 0.68 percent ahead of what inflation would be if the April rate is projected out over 12 months.
One of two things could resolve this situation: either mortgage rates could rise, or the inflation rate could ease. With oil prices on the rise in recent weeks, according to the Energy Information Administration, a drop in inflation does not seem like a safe bet.
Buyers, Sellers and Owners All Affected
The good news is that for the time being, low mortgage rates are still available. Consumers simply need to realize that the relationship between mortgage rates and inflation suggests it may not be possible to sustain those low mortgage rates for long.
This is important because it affects potential home buyers, sellers, and current home owners:
- For home buyers, low mortgage rates can make their purchases more affordable if they act while the opportunity is still available. Certainly, nobody should rush into buying a house, but the mortgage rate opportunity should make house hunting a top priority rather than a back-burner type of activity.
- For home sellers, low mortgage rates increase the pool of potential buyers who can afford the house. This might be the best time of the year to put your house on the market.
- Home owners might find that low interest rates are starting to reopen the refinancing window. Also, this may be a home owner's best opportunity to get an affordable home equity loan.
30-year mortgage rates have been below five percent for about four years now. The danger is that people may be so used to these low mortgage rates that they have become complacent about them. The reality is that rates this low are very much the exception rather than the norm, and if inflation starts creeping up, it could hasten the return of mortgage rates to more normal territory.