Mortgage loans may soon be in flux as a result of changing Federal Reserve policies. Why? Because the Fed's monthly purchases of mortgage-backed securities and other financial instruments has now ended, five years and some $2.5 trillion after it first began. In 2013 -- when rumors that the Fed was just thinking about an end to the program began to spread, mortgage rates instantly rose from roughly 3.35 percent at the start of May for 30-year, fixed-rate mortgages (FRMs) to 4.51 percent just six weeks later.
Now -- with an actual end to the purchase program -- the market's reaction has been, "So what?" According to Freddie Mac, the typical 30-year FRM was priced at 3.98 percent just after the Fed announcement, hardly a sign of marketplace worries. The expectation is that the Fed will try to pressure rates higher sometime next year, perhaps by early summer. It's important to discount such expectations for two reasons. First, they could be wrong. Second, the ability of the Fed to impact mortgage loans is unclear.
The Federal Reserve and Mortgage Loans
We tend to think of the Fed as some sort of rate-setting colossus, but that's hardly the case when it comes to mortgages. Fed Chairman Ben Bernanke has claimed that the Fed's bailout program lowered mortgage rates by as much as 1.2 percent, but who can say? Mortgage rates reflect the supply and demand of money, and there are many forces pushing and pulling on rates. For instance, mortgage origination's this year were predicted to be 32 percent lower than in 2013, according to the Mortgage Bankers Association, largely because so many people financed and refinanced in 2012 and 2013. Does Bernanke also take credit for the slowdown in home sales or the decline in first-time buyer activity?
But perhaps another reason for the Fed's impotence is that we have a national mortgage system that's influenced by events outside our borders, events beyond the Fed's control.
In its October economic commentary, the MBA pointed out that "an unusual number of international factors loom over these forecasts, which may have strong impacts on eventual outcomes. For example, a recent flight to quality, with investors seeking safety in US Treasury securities, has pushed interest rates lower than expected, increasing refinances."
In other words, cash from all over the world comes to the United States looking for a safe haven when economic conditions overseas are uncertain.
Negative Interest Rates
Consider Europe. Right now the European Central Bank pays negative interest. With negative interest if you deposit $1,000 you get back less, say $990. Why would anyone with cash accept negative interest? Because many of the alternative places to put money are worse.
If negative interest does not seem too attractive, perhaps you would like to invest in safe and comfy US mortgage loans. When lots of people make that choice, the US lending system is flooded with cash and rates are pushed down. Right now, by one estimate, US lenders are holding some $2 trillion in excess cash. The same influx of foreign capital which is helping to push down mortgage rates also explains the rise of high-cost real estate in Manhattan and a few other markets. The important point is not that a given condo has a nice view, rather it's the idea that by having a very expensive asset in the US, there's a store of capital here in case things go badly in the old country.
We don't know what will happen to mortgage rates in the future, but we know where they are today. If you want to finance or refinance, shop around -- rates for mortgage loans are low and it can be argued that lenders are now easing credit standards.
Why are lenders increasingly generous and welcoming? Because vaults are now packed with money and idle cash is not the way to create additional wealth.