Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



The Simple Reason Mortgage Interest Rates May Never Be This Low Again

Mortgage interest rates don't materialize out of thin air. At least for the past five years, we have the Federal Reserve to thank for the lowest borrowing costs in decades, if not all of American financial history.

But while people may disagree with the central bank's intervention, there's little dispute about where we're headed next. In the middle of last year, then-Fed Chairman Ben Bernanke intimated that the board in charge of monetary policy had decided to taper its support for the economy.

The impact was swift and dramatic, sending mortgage rates soaring over the course of the last 12 months. It's for this reason that prospective homebuyers shouldn't sit on their laurels any longer hoping that mortgage rates will eventually return to their post-recession lows.

Where do mortgage rates come from?
The Fed was so successful at driving down mortgage rates because the mechanism to do so is actually quite simple.

The interest rate on a mortgage isn't set in the mortgage market itself; it's set instead in the market for mortgage-backed securities.

These are complicated bond-like financial products that are secured by a mortgage or collection of mortgages. As explains:

When you invest in a mortgage-backed security you are essentially lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to worry about whether the customers have the assets to cover the loan. Instead, the bank acts as a middleman between the home buyer and the investment markets.

It follows that mortgage interest rates derive from the prices of mortgage-backed securities. And the prices of mortgage-backed securities derive from demand and supply from institutional investors.

With this in mind, all the Fed must do to increase or decrease mortgage rates is to tweak the dynamics in the market for mortgage-backed securities.

The purpose of quantitative easing
If you've heard the term "quantitative easing" over the past few years and wondered what it means, this is it.

In other words, it's a fancy way of saying that the central bank has decided to drive down long-term interest rates (principally mortgage interest rates) by buying massive amounts of mortgage-backed securities.

As you can see, it's done so on three separate occasions since the end of 2008 -- the three programs are referred to as "QE1," "QE2," and "QE3," respectively.

The impact has been twofold.

First, the Fed's balance sheet has ballooned to more than $4 trillion. And second, mortgage rates fell from above 6% in 2008 all the way down to 3.4% by the end of 2012.

What does this mean going forward?
Suffice it to say, as you can see for yourself, the quantitative easing party came to an abrupt and somewhat premature end in 2013, following hints that the Fed would begin to wind down its third and final bond-purchasing program.

Since then, the central bank has followed through on its promise, affecting a predictable increase in mortgage interest rates.

The point here is that, while the cost of a mortgage will invariably fluctuate on a daily and even hourly basis, there's little doubt where rates are headed over the foreseeable future.

In short, absent an unexpected economic slowdown, the Fed appears to be done with the extreme measures of the post-financial crisis period. And along with this reality come higher mortgage interest rates.

Consequently, for anyone thinking about buying a home, at least from the perspective of mortgage rates, now is as good of a time to do so as you may ever see.

Will this stock be your next multibagger?
Give us five minutes and we'll show how you could own the best stock for 2014. Every year, The Motley Fool's chief investment officer hand-picks one stock with outstanding potential. But it's not just any run-of-the-mill company. It's a stock perfectly positioned to cash in on one of the upcoming year's most lucrative trends. Last year his pick skyrocketed 134%. And previous top picks have gained upwards of 908%, 1,252% and 1,303% over the subsequent years! You don't want to miss what could be his biggest winner yet! Just click here to download your free copy of "The Motley Fool's Top Stock for 2014" today.

Read/Post Comments (0) | 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.

Be the first one to comment on this article.

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: 2989843, ~/Articles/ArticleHandler.aspx, 8/31/2015 10:02:49 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...

John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

Today's Market

updated 46 minutes ago Sponsored by:
DOW 16,528.03 -114.98 -0.69%
S&P 500 1,972.18 -16.69 -0.84%
NASD 4,776.51 -51.82 -1.07%

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