Two More Years of 4% Mortgage Rates?

By:
Kirk Haverkamp | January 28, 2012

The Federal Reserve announced this week that it does not plan to raise interest rates until 2014 at the earliest. Does this mean you can expect another two years of 4 percent mortgage rates?

Not necessarily. While the Federal Reserve plays a major role in determining the cost of borrowing, including mortgage rates, other factors such as inflation and the state of the global economy are important factors as well.
 
What might cause mortgage rates to increase over the next two years despite the Fed’s efforts to keep the cost of borrowing low? Here’s a look at some of main ones.
 

Rates tend to fluctuate

 
            Looking at mortgage rates over the past half century, the one thing that’s been consistent is that mortgage rates tend to fluctuate from year to year. Annual changes of one-half to one percent are the rule, not the exception. Since most analysts feel rates don’t have much more room to fall, that means the only direction for rates to go is up.
 
So by 2014, it’s a pretty good bet mortgage rates will have at least bounced around some, if not changed significantly.
 

What goes down can go back up

 
The Fed’s main tool for influencing interest rates is the Federal Funds rate, which is the rate banks are charged for short-term, overnight loans. It essentially sets the floor for the lowest lending rate available, and affects all other rates above it.
 
The problem is that the Fed effectively cut the Federal Funds rate to zero (actually zero to one-quarter percent) in December 2008 and it’s stayed there ever since. During the three years since, 30-year mortgage rates have followed a meandering path from about 5 percent down to about 4 percent, where they are right now.
 
If they can fall a full percent with the funds rate unchanged, they can gain one too.
 

An economic rebound

 
A stronger-than-expected economy would likely send rates higher, due to increased demand for lending capital, meaning lenders could charge more. A stronger economy could also boost inflation, which always drives up interest rates because lenders have to charge more just to keep up with the declining value of the dollar. If prices are 5 percent higher one year from now, a lender needs to charge 5 percent interest just to keep up, let alone make a profit.
 
Growing inflation might also spur the Fed to boost the Federal Funds rate ahead of schedule to keep a lid on prices, which would boost mortgage rates almost immediately.
 

Higher demand

 
Know what would really send up rates? Increased demand for mortgages. So if home sales take off, or HARP 2.0 (for refinancing underwater mortgages) gets traction, look for rates to pick up. This is somewhat self-limiting, because higher rates would reduce demand for refinancing, which currently makes up about 75-80 percent of all mortgage applications. But if consumers suddenly decide that home values have hit bottom and start buying again, rates could go up quickly.
 

How high might they go?

 
That’s anyone’s guess. Mortgage rates are notoriously difficult to predict. At this point, an increase to 4.5 percent or 5 percent would be considered a significant rise. Even so, that would only be a return to what were considered extremely low rates only two years ago.
 
Then again, two years ago almost no one thought it was possible that 30-year rates might fall below 4 percent, absent a complete collapse of the economy. So you just never know what they might do next. They could just surprise us all.
 
 

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