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Why Interest Rates have Jumped so Quick!

Posted by John Hathorn on October 17, 2013
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Put Ben Bernanke in front of a microphone, and what could possibly go wrong?

Lots, it seems, if you’re trying to buy or refinance a home. Mortgage costs have soared over the past month after the Federal Reserve chairman told a news conference that, later this year, his bank will start scaling back its long-running effort to boost the economy by driving interest rates down. The average cost of 30-year, fixed-rate home loans — the most popular way to finance a home — shot up nearly a half point and is now more than a point above the record low set last December. The average cost of 15-year mortgages — a favorite with homeowners looking to refinance — rose nearly as much and is nearly a point higher than the record low reached just last month. Indeed, the typical rate for virtually every type of home loan is higher than it’s been since July 2011, according to our most recent weekly survey of major lenders

Where you live no longer plays as big a role in how much you’ll pay for a home loan, either. Over the past year borrowers in the cities with the most costly mortgages routinely paid a point or more higher than those in the cities with the cheapest mortgages. But that spread has collapsed to less than a half point over the past week, with the cheapest loans in Detroit (where the average 30- year rate is 4.44%) and the most costly in Tampa at 4.85% Of course, savvy borrowers with decent credit can expect to pay a quarter point to half point less than these average rates. But the generally higher interest rates means borrowers will have to shoulder bigger monthly payments this summer. The principal and interest for a 30-year, fixed-rate loan at 4.61% is $513 per month for every $100,000 borrowed. That’s $63 more than the typical home financing would have cost on May 1, when the average cost was just 3.52%.

The only encouraging trend we see is that lenders seem to be making it a  little easier to qualify for home loans. The average FICO credit score for home buyers whose conventional loans closed in May was 761, three points lower than in May 2012, according to Ellie Mae Inc., a California-based mortgage technology firm whose software is used by many lenders. The average FICO score for homeowners who refinanced through a conventional loan was 756, a full 10 points lower than last May. For more than five years the Federal Reserve has pursued an aggressive policy to push long-term borrowing costs down and spur our lethargic economy to grow faster and create more jobs. How does it do that?

Since last September, the bank has been buying about $85 billion in long-term debt a month — $45 billion in Treasury bonds and notes and $40 billion worth of mortgages. When the Fed buys bonds backed by thousands of home loans, it essentially floods the market with money, pushing down the cost of financing a home. That’s why mortgage rates plunged to new record lows much of the past year.

But the Fed has now purchased more than $3 trillion worth of government and government-backed mortgage debt since the financial crisis hit in 2008 — and that’s a lot, even in the mega-banking world it inhabits. Early this year, the Fed’s rate-setting committee began debating when to end those purchases, with some members pushing to cut back this summer, while others urged the Fed to stay the course at least until fall. But it was Bernanke who shook the financial industry in late May when he told a congressional committee that, “We could in the next few meetings take a step down in our pace of purchases.”

That was a clear-enough signal to send the stock markets tumbling and trigger a late-spring spike in long-term interest rates. Then Bernanke stepped before the microphones again after the Open Markets Committee meeting on June 19 and elaborated on that plan. The powerful banker said the Fed will begin to scale back purchases of Treasury and mortgage-backed bonds later this year and end them altogether when the unemployment rate hits 7%, a milestone Bernanke expects to reach by the middle of next year.

That has prompted nervous banks, credit unions and mortgage companies to charge more for home loans now, in anticipation of that change in policy.

Other members of the Fed’s rate-setting committee have spoken out over the past few days, arguing that the stock and bond markets are overreacting to Bernanke’s statements.

But, really, what did they think was going to happen?

After intervening in the economy for so long, and on such an unprecedented scale, any hint that the Fed was going to take its money and go home was bound to create upheaval.

We suspect there will be lots more as borrowing costs lurch back toward more normal, market-driven rates. I would love to know if you have any thoughts on
this. Is this going to slow down our crazy hot real estate market? Or are we going to continue double digit appreciation going into 2014?

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