By Jacob Passy
(Getty Images)
Mortgage rates are already rising in response to the Federal Reserve’s hawkish stance on inflation, but home buyers may not need to worry about having trouble qualifying for a home loan in the months to come.
The 30-year fixed-rate mortgage averaged 3.12% for the week ending Dec. 16, up two basis points from the previous week, Freddie Mac reported Thursday. The current average rate for the 30-year loan is now nearly half a percentage point higher than it was a year ago.
The 15-year fixed-rate mortgage, meanwhile, dipped four basis points to an average of 2.34%. The 5-year Treasury-indexed adjustable-rate mortgage averaged 2.45%, unchanged from the previous week.
The Fed is set to pump less liquidity into the mortgage market
This week’s increase to the benchmark mortgage rate is likely just the beginning. The Federal Reserve is scaling back its stimulus activities at a quicker pace than previously expected given the high rate of inflation. In particular, the central bank announced that it would reduce its purchases of mortgage-backed securities (MBS) at a faster rate than previously expected.
Those purchases pumped a ton of liquidity into the mortgage market, which allowed mortgage lenders to slash interest rates amid the pandemic and spark a major refinance wave. Without those purchases, banks will need to take the opposite approach and increase rates.
“The Fed has been in there buying every single day, multiple times a day, with respect to the MBS market,” said Mike Fratantoni, chief economist at the Mortgage Bankers Association. He added that over the past couple years the Fed purchased essentially “all of the new production” of these securities.
Other investors are expected to fill in the gap left by the Fed, but it’s unlikely that the market for these securities will see the same consistency.
“There are going to be other buyers, but there’s just no other buyer that acts like that,” Fratantoni said. “Some days they’ll be excited to buy MBS, and some days they won’t. That’s what leads to our expectation that we’re going to have a more volatile mortgage rate environment than we’ve had the past couple of years.”
The Fed’s response to high inflation could affect mortgage rates in other ways
Additionally, the Fed is planning to hike the federal funds interest rate three times next year. The federal funds rate doesn’t have a direct effect on mortgage rates, which are instead more likely to be influenced by movements in long-term bond yields including the 10-year Treasury note. Still, expectations of interest-rate hikes from the Fed are baked into the long-term view investors take—and that does have an indirect effect on the direction of mortgage rates.
Depending on how consumer prices respond to the Fed’s tapering and rate hikes, the central bank may need to take more drastic action. While the Fed will slowly stop growing its portfolio of mortgage-backed securities in the months ahead, even after that point it will need to periodically purchase more mortgage notes to maintain the size of that portfolio. That’s because mortgage-backed securities can mature ahead of schedule if there are prepayments, either because borrowers refinanced their loans or sold their homes.
Analysts at Wrightson ICAP projected that after the tapering had finished, the Fed could still be buying around $60 billion in mortgage-backed securities to maintain its portfolio’s size in such a scenario. The analysts projected that the central bank would not want that outcome, and could instead choose to shift some of that money toward buying Treasuries instead.
Such a move would shrink the bank’s portfolio of mortgage-backed securities, which can be riskier investments. Nevertheless, such a move would have the effect of reducing liquidity in the mortgage market even further.
Qualifying for a mortgage may soon be easier
Higher interest rates have already drastically cut into the volume of refinancing applications, and that trend is expected to continue into the New Year. In 2021, the Mortgage Bankers Association estimates that lenders will have doled out $2.32 trillion in refinance loans. Next year, they predict that the volume of refinances will drop to just $860 billion.
Consequently, lenders will need to shift their attention toward the so-called purchase market, meaning mortgage applicants who need a loan to buy a home.
“Lenders are thirsty for volume as refinancing traffic wanes and the investors that buy mortgage debt are still very much in a ‘risk-on’ mode,” said Greg McBride, chief financial analyst at Bankrate. “Until either of those changes, there isn’t an obvious catalyst for a tightening of mortgage credit.”
Indeed, the opposite outcome is more likely, according to economic and housing experts. Most expect that lenders will aim to make it easier to qualify for a home loan in order to compete for home buyers’ attention.
This would represent a major turnaround from the start of the pandemic, when lenders made it harder to get a mortgage. At that point, in light of the sudden recession, lenders implemented stricter standards for prospective borrowers to meet, including higher credit scores and income requirements. The large volume of refinance applications made this feasible, because they weren’t short on demand.
In 2022, it’s likely that lenders will resume offering low-down payment loan options and adding flexibility to underwriting standards, Fratantoni said. This could make it easier for many borrowers to qualify for a loan, including people who are self-employed or work in the gig economy.
“The regulatory constraints are still pretty tight, so the ability-to-repay and qualified-mortgage standards really limit the extent to which credit could loosen,” he said.
Of course, the competitive housing market means that some home buyers will still be out of luck. While rising interest rates are expected to slow the rate of home-price growth, it will still be more expensive to buy a home in 2022 than it was this year. For families struggling to save up for a down payment, even more relaxed credit standards won’t make it feasible to become homeowners.
“Borrowers have to be able to qualify for loans at the higher rates, which will reduce the pool of eligible borrowers,” said Ruben Gonzalez, chief economist at Keller Williams.