What the Past Can (and Can't) Tell Us about Future Mortgage Interest Rates

Mortgage interest rates are rising. How far will they go? While history can’t give us a precise answer, it can give us some idea of what the possibilities are. The short answer is this: you may have seen the last of 3.5 percent 30-year mortgage interest rates.

While history never repeats itself in an orderly manner, it is an important guide to what types of conditions you can normally expect from financial markets, the economy, and interest rates. In the space of just a few years, people have gotten used to sub-five percent mortgage interest rates as if they were the new normal. A look at mortgage history shows just how far from normal they really are.

The following are five ways of looking at historical mortgage data for some perspective on what to expect from mortgage rates going forward:

1. The long-term average. Statistics on 30-year mortgage interest rates are available from the Federal Reserve going back to April of 1971. The average monthly mortgage rate since then is 8.62 percent. So, as a simple and straightforward definition of what a “normal” mortgage rate would be, you could start with this long-term average.

2. The most common mortgage interest rates. One problem with a straight average is that one or two pieces of outlying data can skew the average in an unrepresentative way. So another way to define a normal level of mortgage rates is to look at what level has occurred most often. Based on annual averages from mortgage finance company Freddie Mac, in the 41 complete calendar years of data available, the most frequently occurring ranges for mortgage rates are six to seven percent, seven to eight percent, and eight to nine percent, each of which has occurred six times. This means that annual mortgage rates have been somewhere between six and nine percent about 44 percent of the time since the early 1970s. This suggests that the long-term average of 8.62 might be skewed upward by about one percent due to outliers.

3. Inflation-adjusted mortgage rates. So far, the history of mortgage rates shows they can be much higher than the current level of around four percent, but then again, for much of that history inflation was much higher than it is now. According to the Bureau of Labor Statistics, over the same time that 30-year mortgage interest rates were averaging 8.62 percent, inflation was averaging 4.3 percent a year. This means that typically, 30-year mortgage rates build in a 4.32 percent cushion over inflation. With annual inflation recently running at just 1.4 percent, applying that same cushion over inflation would suggest that a 5.72 percent mortgage rate would be normal under current conditions.

4. The potential for increase within the next year. Sure, mortgage rates could move much higher than they are now, but how quickly could that happen? Won’t consumers have time to act before things change too radically? Well, in the past, mortgage rates have increased by as much as 5.83 percent in a single year. That would suggest that from their current level of around 4 percent, mortgage rates could jump to as high as 9.83 percent in the next year.

5. The extreme. Most of the above examples are based on historical norms, but if you are a worst-case-scenario type of person, you may want to know just how high history shows mortgage rates can reach. That number is 18.45 percent, which was reached in October of 1981. That’s the extreme high and therefore not likely to be reached again, but it’s equally important to remember that current mortgage rates are fairly close to the extreme low, and thus also unlikely to occur again.

The Limitations of History

History is useful, but it is far from a perfect guide. Prior to 2003, the history on 30-year mortgage rates would have shown that they had never dropped below six percent. Thus, rates below that level would have been hard to foresee, but in fact mortgage rates have been below six percent for most of the time since then. History can help us understand what is most likely to happen, but it cannot account for everything that could possibly happen in the future.

What the history examined above tells us about what is most likely to happen to mortgage rates is the following: if inflation remains under control, mortgage rates are likely to rise to into the high-five percent range. If inflation perks up to more normal levels, then mortgage rates would be more likely to reach the eight- to nine-percent range.

Takeaways for Consumers

While history can’t tell you exactly what’s going to happen next, it does make it clear that you should not take mortgage rates in the four percent range for granted. This knowledge should inform your mortgage decisions in a variety of ways:

1. If you’ve been wondering when to buy a house, sooner might be better than later, since mortgage rates are already moving higher. 

2. If you can save money by refinancing, don’t hold out for an even better deal. What you see now may be the best chance you get.

3. If you are trying to decide between adjustable and fixed-rate mortgages, keep in mind that the potential for rates to rise from current levels makes adjustable-rate mortgages especially risky right now. Unless you have a very special set of circumstances, lean toward the certainty of a fixed rate mortgage.

In a way, studying financial history is a way of gaining decades of experience without having to put in as much time or suffer through the setbacks. That kind of experience is exactly what consumers need to make more informed decisions about mortgages.

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