According to Federal Reserve data, as of mid-year 30-year fixed mortgage rates were still among the lowest of all time. One factor in allowing mortgage rates to remain so low over the past five years has been an unusually mild inflation rate. However, a surge in consumer prices in the second quarter of 2014 may have sounded the alarm for mortgage shoppers - act now, or you may pay for it later.
Mortgage Rates Hang in There
30-year fixed mortgage rates ended the first half of 2014 at around 4.16 percent. Though this is a little higher than the all-time low reached in early 2013, it is still lower than mortgage rates have been 95 percent of the time historically. This is despite two things that threatened to push mortgage rates considerably higher:
- A rebounding economy. Employment data from the Bureau of Labor Statistics (BLS) showed that job growth exceeded 200,000 for five of the first six months of 2014. The Bureau of Economic Analysis announced that the economy overall grew at a healthy annual rate of 4.0 percent in the second quarter. A stronger economy should eventually bring more demand for loan and investment capital, which would tend to push interest rates back up towards more normal levels. So far though, perhaps because of numerous false starts for the economy in recent years, interest rates have been slow to respond to signs that the recovery is gathering momentum.
- Shifting Fed policy. Since the beginning of the year, the Federal Reserve has been tapering off on its bond buying program - a program specifically designed to bring long-term interest rates like 30-year fixed mortgage rates down. However, though mortgage rates initially jumped when talk of an end to that program began, they have not come close to the levels they were at before that program began.
While mortgage rates have not responded much to the above factors, the thing that could force lenders to raise mortgage rates more assertively is inflation.
The Inflation Threat
The nature of the inflation threat is pretty straightforward. Lenders want to make sure they get back at least as much purchasing power as they lend out, so they build an allowance for inflation into their interest rates. Thus, they tend to be sensitive to signs that the inflation rate might be higher going forward than it has been recently, and lately, inflation has been on the rise.
According to the BLS, over the past year the Consumer Price Index rose by just 2.1 percent, but in the second quarter of 2014, it increased at an annual rate of about 3.5 percent. What does this imply for mortgage rates?
Over the past five years, 30-year fixed mortgage rates have averaged about 2.5 percent over the rate of inflation. With inflation at 2.1 percent over the past year, that would imply a normal 30-year mortgage rate should be about 40 to 50 basis points above the recent level of 4.16 percent. However, if inflation continues to run at the second quarter pace of 3.5 percent, that would imply that 30-year fixed mortgage rates should rise to 6 percent.
In short, if the recent surge of inflation continues, it has the potential to significantly shake up the mortgage rate environment.
How should consumers respond to this threat to low mortgage rates? It depends on their situation:
- People looking to buy a home should make the house-hunting process a priority, because rising mortgage rates could force you to lower your price target if you delay.
- Home owners looking to stay in their homes should take a long look at whether refinancing makes sense under the current rate environment, because it might be the best chance you get for years to come. Also, home owners interested in borrowing against home equity may want to act now, before borrowing costs rise.
- Home owners looking to sell might want to get on the market now. If mortgage rates rise significantly, expect the pool of potential buyers to dry up, and housing prices to weaken.
Inflation is just the latest of multiple threats to low mortgage rates, and these threats all add up to one thing: a reminder that the low mortgage rates of recent years are the exception, rather than the rule. Anybody still looking to act on those low rates should recognize that any delay could mean missing the opportunity.