Why Are Mortgage Rates So High?

At last glance, the 30-year fixed mortgage was back above 7%, depending on the data source.

Prior to late July and early August, the popular loan product could be had for closer to 6.5%. Or even in the high 5s if paying points.

And forecasts from prominent economists pointed to rates making their way back to the 5s, or even the 4s by next year.

Then rates suddenly reserved course and continued their upward climb, challenging the high levels seen last November.

The question is, why are mortgage rates so high? And why aren’t they coming down if the Fed is done hiking and inflation is abating?

Blame the Resilient Economy for High Mortgage Rates

As a quick refresher, good economic news tends to lead to higher interest rates.

And bad economic news typically results in lower interest rates.

The general logic is a hot economy requires higher borrowing costs to slow spending, otherwise you get inflation.

Meanwhile, a cool economy may require a rate cut to spur more lending and get consumers spending.

Unfortunately, the economy continues to defy expectations, in spite of the many Fed rate cuts already in the books.

Since March of 2022, the Fed has raised their key fed funds rate 11 times, from near-zero to a range of 5.25-5.50%.

This was deemed necessary to battle inflation, which had spiraled out of control, causing the prices of everything, including single-family homes, to skyrocket.

While the Fed has more or less signaled that it’s now in a wait-and-see holding pattern, mortgage rates have continued to march higher.

The reason is hot economic data, whether it’s the CPI report, jobs report, retail sales, etc.

Sure, some of these reports have come in better than expected recently, but it’s never convincing enough to result in a mortgage rate rally.

On top of that, Fitch recently downgraded the credit rating of the United States, citing “expected fiscal deterioration over the next three years,” along with growing government debt.

Nobody Believes the Inflation Fight Is Over

While the Fed doesn’t set mortgage rates, its own fed funds rate does dictate the general direction of long-term interest rates such as those tied to home loans.

As such, rates on the 30-year fixed (and every other type of mortgage loan) increased markedly since early 2022.

Those 11 rate hikes translated to a more than doubling of the 30-year fixed, from around 3% to 7% currently, as seen in the illustration above from Optimal Blue.

It was further exacerbated by a widening of mortgage rate spreads relative to the 10-year Treasury.

And while the Fed appears to be satisfied with its rate hikes, they’re still watching the data come in each month.

Without getting too convoluted here, nothing has convinced Fed watchers that a rate cut is in the cards anytime soon.

Simply put, this means mortgage rates may need to stay higher for longer, even if the Fed is done hiking.

Compounding this higher-for-longer narrative is the U.S. deficit and their larger-than-anticipated borrowing costs, which will require selling more bonds.

This puts additional pressure on interest rates as the supply of bonds grows and their associated rates increase.

But that’s just the latest sideshow. The overarching theme is that the economy remains too hot, unemployment too low, and consumer behavior not much changed.

Despite much higher borrowing costs, whether it’s a mortgage, a credit card, a HELOC (whose rates are up about 5% from 2022 thanks to the increase in the prime rate), the economy keeps chugging along.

There has yet to be a recession and the stock market has been resilient. In other words, there’s really no reason to lower interest rates and reduce borrowing costs.

Why would the Fed do that now, only to risk another surge in inflation? Or another home buying frenzy.

What Would Lower Mortgage Rates Mean for the Housing Market Today?

Let’s consider if mortgage rates finally did trend lower in a meaningful way.

Despite some short-term victories over the past year, they’re pretty much back near their 20-year highs.

If they did happen to fall back to say the 5% range, what would what mean for the housing market?

In case you haven’t heard, Zillow expects home prices to rise 5.5% this year after beginning the year with a decidedly bleaker -0.7% forecast.

This figure is “roughly in line with a normal year,” despite those 7% mortgage rates.

But what would happen if rates came down to 5%? Would we see a return to bidding wars and offers well over-asking?

Would home price appreciation reaccelerate to unhealthy levels again?

The answer is most likely yes. And this kind of sums up why the Fed isn’t going to just start cutting its own rate anytime soon.

All their hard work would be in vain if inflation notched higher again and their so-called housing market reset became awash.

Even if a rate cut does come as early as 2024, it might only be a 0.25% or something relatively insignificant, which may not move the dial on mortgage rates much.

Like the Fed, mortgage lenders (and MBS investors) are defensive as well. This explains why it has been really hard to see a meaningful mortgage rate rally in 2023.

Even when a jobs report or CPI report comes in cooler than expected, it quickly gets overshadowed by something else.

And that’s just the nature of the trend right now, which isn’t a friend to mortgage rates.

This will eventually change, but it could take longer than expected for mortgage rates to finally reverse course.

Similar to how they stayed low for so long, they may remain elevated well beyond the rosy forecasts indicate.