Is the Fed Determined to Raise Mortgage Rates?

In minutes of a recent Federal Open Market Committee meeting, some members expressed concern about inflation. The Fed being concerned about inflation may not strike you as odd, but in this case the concern was that inflation was too low, not too high. This is the second signal in recent months that the Fed might be headed in a policy direction that leads to higher mortgage rates.

Would-be home buyers, along with anyone in a position to refinance a mortgage or get a home equity loan, should pay attention. Fed policy has been instrumental in driving mortgage rates down to record lows. A change in that policy could just as readily lead to higher mortgage rates - especially when current home mortgage rates are still at unusually low levels.

The Fed's concern with inflation

According to the Bureau of Labor Statistics, the Consumer Price Index increased by just 1.5 percent over the past year. To anyone who remembers "Whip Inflation Now" buttons from the 1970s, such a mild level of inflation might seem like reason for policymakers to cheer. In the current context though, the Fed is concerned that such low inflation is symptomatic of the recent economy's chronic weakness.

Low inflation is not necessarily a sign of a weak economy. During the last three years of the 1990s, inflation averaged just 2 percent while real Gross Domestic Product grew at an average rate of 4.6 percent a year. In the current context though, some members of the Fed are concerned that pricing weakness may put a further damper on economic activity.

Though the Fed might like to see higher inflation, the downside for mortgage shoppers could well be higher rates. Add to this the fact that the Fed is already tapering off the bond purchases that led to record low mortgage rates, and that makes two reasons to suspect the Fed might be content to let mortgage rates rise. After all, current home mortgage rates are still well below historically normal levels.

What normal looks like

The last thing mortgage shoppers want is for mortgage rates to return to normal. The Federal Reserve now has 43 years worth of mortgage data available, and over those 43 years, 30-year fixed mortgage rates have averaged 8.5 percent. In contrast, current home mortgage rates are right around 4.3 percent.

That 8.5 percent historical average came with an average inflation rate of 4.2 percent; today's inflation environment is very different. However, this suggests that 30-year fixed mortgage rates are normally about 4.3 percent above inflation. If this relationship held true, today's mortgage rates would have to rise to 5.8 percent. Plus, if the Fed allows inflation to rise, mortgage rates could rise even higher.

Avoiding higher mortgage rates

Whether your plans are to get a mortgage, refinance a mortgage, or get a home equity loan, avoiding the possibility of higher mortgage rates should be a priority. Here are three tips for avoiding higher mortgage rates:

  1. Act decisively. 30-year fixed mortgage rates stayed below 4 percent for a year-and-a-half, just long enough to create the feeling of a new normal. The truth is that what's normal for mortgage rates is to be on the move, so don't get complacent about current home mortgage rates. They may be up from a year ago, but as the analysis above shows, there is plenty of room for them to move higher.
  2. Consider a shorter mortgage. According to mortgage finance company Freddie Mac, there is nearly a full percentage point between 30-year and 15-year mortgage rates. So, if you want to turn back the clock to when mortgage rates were about a point lower than they are today, a shorter mortgage is one way to do it, as long as your monthly budget can afford the shorter repayment period.
  3. Get competing mortgage quotes. When mortgage rates rise and fall, mortgage lenders do not all react in lockstep. There will always be a high and a low rate to be had on any loan, and getting competing quotes is the best way of making sure your mortgage rate is on the lower end of the scale.

For a while there, mortgage borrowers had the Fed squarely in their corner. Now, not so much, but you can still win as long as you are not passive about getting yourself the best mortgage rate available.


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