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 Investopedia.com 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.
