Why Are Mortgage Rates Rising So Much?
Why Are Mortgage Rates Rising So Much?
The Federal Reserve Bank and Interest Rate Increases
The Federal Reserve Bank have raised interest rates 10 times in the last year, the most dramatic increase in the last 15 years. The reason for this is tied primarily to inflation. Inflation is at a 20 year high and headed for the 8% range.
So why is the Fed raising rates? Inflation is the number one enemy of low interest rates because it erodes the interest rate return on bonds. The price of bonds (mortgage backed) securities determines the fixed rates of mortgages, not the FED. For example, if a bond is sold at 3% for say $100,000, the buyer earns the interest on that of $3,000 a year. If inflation is at 10%, you are losing 7% on that money, so the buyer sells that bond. The selling of that bond raises interest rates because no one wants to hold a 3% bond any more and therefore the interest rate ceases to exist. So the anticipation of what the FED is going to do is what prompts the private bond holder market to sell bonds thus increasing interest rates.
The Federal Reserve contributes to mortgage interest rate hikes, but not directly. When it is said that the FED raised rates, it has nothing to do with mortgage rates.
In order to understand how interest rates are changed by the FED, you have to understand how banks borrow money to maintain reserves. The FED has the choice to raise two types of rates. One is called the Federal Funds rate (the rate that member banks can borrow from one another) and the other is called the Discount Rate (the rate at which banks borrow money from the FED) which affect member banks, not mortgage rates.
Member banks of the Federal Reserve Bank have to maintain a reserve of 3 to 10% of the what they loan out. If they have busy lending day, and their reserve requirements fall, they have to either borrow over night from a member bank (called the Federal Finds rate) or borrow directly from the Fed which is called the Discount Rate. Most banks don’t want to go directly to the FED to borrow at the discount rate, prefer to borrow from a member bank. The current Federal fund rate and discount rate is 5.25%. That may not seem like a lot, but last year at this time, it was almost .01%. Banks were borrowing for less than 1% interest.
When the FED raises rates say .25% on either one of those indices, it automatically raises the Prime Rate, which in turn directly affects credit card rates, HELOCS (mortgage lines of credit) and generally affect what interest rate banks lend, except for first mortgage loans. Currently the prime rate is 8.25%. This tightening and raising of rates again affects the bond market for the same reason inflation affects the bond market. Rising borrowing rates make it unprofitable for bond traders to hold a lower bond interest rate and so they sell it, raising mortgage interest rates. Additionally. The FED has been buying bonds at low yields every day since last year, keeping mortgage rates low. This policy ended last March, not this one, when the FED began raising interest rates in 2022. This news has spooked low interest rate mortgage bond holders and they have been unloading low interest rate bonds, since this news hit, which automatically raises mortgage rates. Further news of inflation spooked both the Fed and the bond market and rates have been rising in both the first mortgage market and at the banks.
Ralph Migliozzi
Broker Originator Serving Northern California
NMLS 282851 DRE #01002038
(p) 530-330-3073
