Tarot cards may be great fun, but they won't shed any light on the future of mortgage rates. If you want to know how rates are trending, slip on your reading glasses and start taking notes.
For several years, the media has told us that fixed mortgage rates are "historically low." This descriptor doesn't mean much without some understanding of what "historically high" mortgage rates look like. To put things in perspective, here's a look at how mortgage rates have trended over the past three decades on 30-year, fixed-rate loans. The numbers shown are the highest annual average rates for each decade, according to Freddie Mac's Primary Mortgage Market Survey.
- 1981: 16.63 percent
- 1990: 10.13 percent
- 2000: 8.05 percent
The average rate for 2009 was 5.04 percent. And in 2010, monthly averages have dipped below 4.5 percent. In other words, a mortgage loan today costs you half of what it would have 10 years ago.
Looking at history, it's reasonable to conclude that mortgage rates will eventually rise from these levels. Unfortunately, it's tough to predict when that will happen. Certain factors, such as general economic uncertainty and ongoing foreclosure crisis actions, are holding rates down-for now. Still, there are some indicators that you can watch to detect the start of a new mortgage rate trend.
Consumer Price Index (CPI). Much of the money that's funding the mortgage industry comes from investors who purchase mortgage-backed securities. The CPI measures inflation, and inflation impacts the yield that investors earn on fixed-income securities, including the mortgage-backed variety. When inflation rises, investors demand higher yields. This puts upward pressure on fixed mortgage rates.
Sometimes, that upward pressure acts quickly. In 1981, for example, mortgage rates rose 3.5 percentage points in less than a year. This explosion followed a trend of double-digit inflation.
- 30-year Treasury bond rates. Mortgage rates tend to move with bond rates because the two instruments are competing investments. Yields on mortgage-backed securities need to be higher than yields on less risky Treasury bonds, but not so high that prospective homeowners can't afford a loan. These dynamics create a situation where mortgage rates will move up only enough to keep the secondary market investors interested. Barring other factors, if bond yields rise, mortgage rates will often follow.
- Employment Cost Index (ECI). A steep rise in labor costs can predict inflation, because companies will feel pressure to raise their prices to maintain profitability.
- Home sales. The large inventory of foreclosed properties on the market is motivation for federal strategies to keep mortgage rates artificially low. Rising demand for existing homes would help clear out these foreclosures, laying the groundwork for a more normal mortgage rate environment. You can follow existing home sales on the National Association of Realtors' web site.
If you're in the market for a home, don't wait until inflation flares up to get the process started. The above indicators won't provide definitive predictions about mortgage rates, but they're better than Tarot cards for signaling trends.