Why Are Mortgage Rates So Low?

Mortgage rates are holding steady, and that seems curious given that real estate demand is on the rise. What we may be seeing are rates influenced by something other than the expected components of supply and demand.

There is now considerable evidence that the housing market has begun to return. According to Frank Nothaft, Freddie Mac's chief economist, "the median sales price of existing homes rose 10 percent between fourth quarter 2011 and 2012, the largest year-over-year gain in seven years. Among large metropolitan areas, 88 percent saw positive annual increases in the fourth quarter.”

It's not just that home prices are rising; sale volume is also increasing. The National Association of Realtors says that in the fourth quarter existing home sales were up 12.1 percent over the previous years.  Annualized, that’s about 500,000 more transactions per year.

One, Two, Three

If we seemingly have more demand for mortgage financing, why aren’t rates higher? Three reasons seem to stand out:

  1. First, cash transactions now represent 29 percent of the existing home market, according to the NAR, meaning that more home sales do not necessarily mean a proportional increase in mortgage demand.
  2. Second, the world economy is not particularly stable. It makes a lot of sense for investors and institutions worldwide to move their money into the American economy -- at least it’s showing signs of recovery. This is referred to as “flight to quality” by analysts.
  3. Third, federal policies are subsidizing mortgage rates. Federal Reserve Governor Jeremy C. Stein says mortgage rates dropped .2 percent in September, when the government announced that it would purchase an additional $40 billion mortgage-backed securities per month.

That $40 billion is in addition to the $45 billion in long-term securities that the Fed was already buying. That's $85 billion a month or better than $1 trillion a year.

So how long will the Fed continue its buying mission? It says it will “continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability.”

Translation: The Fed will continue buying MBS for the foreseeable future.

Pulitzer-prize winning economist Paul Krugman agrees with the Fed's plan. As he told Bloomberg Surveillance, “we have the beginnings of a housing recovery, it’s just starting to kick in."

Actually, we know that at this moment many local housing markets have improved and stabilized -- but the economy remains generally weak in terms of employment, exports, and the deficit. We don't know how long such improvement will continue or if it will continue at all. One result is that vast numbers of people are refinancing now, locking in today's interest levels because if mortgage rates go up you have a hedge -- and if rates decline you might want to refinance.

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