Recs

2

6% Mortgage Rates Could Come Sooner Than You Think

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Homeowners have enjoyed rock-bottom mortgage rates for years now. But with the recent spike up in bond yields, mortgage rates have followed suit, climbing a full percentage point to about 4.5% for 30-year mortgages in just the past two months. Given the speed of the rate increase, concerned would-be homebuyers are wondering just how far mortgage rates could climb.

A recent column from financial analyst Richard Barrington asked how quickly rising mortgage rates could come, and he argues that 6% rates could be just a year away without anything more extraordinary than a return to more normal conditions in the credit markets. Let's take a closer look at the arguments for and against continued rises in mortgage rates and the impact they could have on your finances.

Focusing on margins
One way to look at mortgage rates is from the perspective of the lenders that make mortgage loans. As Barrington notes, lenders have to pay special attention to the potential for future inflation because the long-term nature of mortgage loans can potentially leave them exposed to interest-rate risk for decades. Historically, when you look at the spreads that lenders have demanded over expected inflation rates over the past 40 years, you find mortgage rates that were typically almost 4.5 percentage points above the rate of inflation. Therefore, when you look at past inflation since 2008 that has averaged about 1.5%, you get a "standard" mortgage rate of 6% once those spreads get back to normal.

Interestingly, though, this analysis doesn't mention an important factor: Increasingly over the past decade, major mortgage lenders haven't held onto their loans but rather have sold them on to government-sponsored enterprises Fannie Mae (NASDAQOTCBB: FNMA  ) and Freddie Mac (NASDAQOTCBB: FMCC  ) . During the housing boom, mortgage lenders Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) didn't perform as well as they did because they were securing particularly high margins on their mortgage loans. Rather, they collected transaction-based income by immediately reselling conforming loans to Fannie and Freddie, often retaining streams of income from risk-free mortgage-servicing rights without keeping any liability for potential loan default. Even now, Wells Fargo (NYSE: WFC  ) relies on strength in mortgage-related income, and decreases in refinancing activity pose a threat to income growth in future quarters -- although unlike many of its peers, Wells has actually retained a good portion of its loans on its own books.

Fannie Mae headquarters in Washington, D.C. Image source Wikimedia Commons, by Nick Anfinsen.

Will the government allow mortgage rates to rise further?
The recent hit to the bond market has led many to question just how much influence the Fed can exercise over long-term rates in the long run. Even the possibility of cutbacks on its bond-buying program was enough to send rates soaring, prompting several Fed officials to take issue publicly with what they saw as an overreaction in the bond market to the message that policymakers were trying to send. With the Fed continuing to buy bonds with particular attention to the mortgage-backed bonds that help keep mortgage rates low, it would take a complete loss of control from the Fed to allow mortgage rates to hit 6% in anything approaching the 2014 timeframe that a reversion to normal interest spreads would imply.

Still, given the government's interest in keeping the economy growing, allowing a quick rise in mortgage rates to 6% would probably cause substantial collateral damage. Home prices that have risen by double-digit percentages over the past year would suddenly be in jeopardy of dropping, as monthly payments on a $250,000 mortgage would rose from around $1,125 at 3.5% to almost $1,500 at 6%, making homes much less affordable for many prospective borrowers. Homebuilders that have seen big recoveries in buying demand would suddenly see buying interest dry up, and the employment prospects for workers in the industry as well as those helping to provide related services would decline as well. That's a downward spiral that the Fed can't afford to allow to happen.

Be ready, but be patient
Eventually, a return of mortgage rates to more normal levels in the 6% range seems likely. But it will only happen once the economy shows signs of being able to withstand the pressures on economic growth that would come with such an increase. That doesn't seem likely by next year, but it could come sooner than you think -- and so being prepared and taking advantage of still-low rates while they last makes long-term financial sense.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 29, 2013, at 10:19 AM, normgarry wrote:

    As rates go up, the number of people able to qualify for mortgages reduces - which allows more houses of the newly deceased/vacated to increase the supply. SUPPLY AND DEMAND.

    I'm not worried. I bought a house (front/backyard with 3 bedrooms 2 bath, 2 kitchens and a florida room - with wide streets and a garage) in a great area inside Queens NYC with property taxes lower than Nassau County. People living in LI would KILL to get my house!

  • Report this Comment On June 29, 2013, at 10:51 AM, sabebrush6 wrote:

    Remember folks, at whatever the rate you end up with, do two things:

    1. Go for a 20 or 25 year mortgage if at all possible.

    2. Make sure before you sign a contract that you can add extra principle money to the payment each month ( on your terms) and it will go directly to the principle balance. Watch the weasel wording from the loan company. Adding a payment at the end doesn't affect the principle.

  • Report this Comment On June 30, 2013, at 5:28 PM, jasjfarrell wrote:

    The government should have gotten out of the way years ago and let the market take it's course.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2516610, ~/Articles/ArticleHandler.aspx, 9/1/2014 5:22:18 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

Today's Market

updated 2 days ago Sponsored by:
DOW 17,098.45 18.88 0.00%
S&P 500 2,003.37 6.63 0.00%
NASD 4,580.27 0.00 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/29/2014 4:04 PM
BAC $16.09 Up +0.08 +0.00%
Bank of America CAPS Rating: ***
C $51.65 Up +0.26 +0.00%
Citigroup Inc CAPS Rating: ***
FMCC $3.82 Down +0.00 +0.00%
Freddie Mac CAPS Rating: **
FNMA $3.89 Up +0.02 +0.00%
Fannie Mae CAPS Rating: **
WFC $51.44 Up +0.29 +0.00%
Wells Fargo CAPS Rating: ****

Advertisement