Experts are predicting that homebuyers may soon see some relief in the form of lower mortgage rates. According to a report released by Freddie Mac, mortgage rates are heading in the right direction and the economy remains resilient, both positive signs for the housing market. The rate for 30-year fixed-rate mortgages has dropped to 6.77 percent, the lowest level since mid-March.
Economist Gerald Dwyer explains that there are two components that contribute to the elevated mortgage rates: long-term Treasurys and prepayment risk. He believes that both components will come down in the short term. Long-term Treasurys are expected to decrease, and the risk of prepaying new mortgages will decline as rates fall.
Mortgage rates are based on the 10-year U.S. Treasury bond, which is considered the risk-free rate of return for investors. Treasury bonds are seen as having the lowest default risk due to America’s history of always paying its debts. However, loans also include a risk component, which is the chance that the borrower will default or refinance and pre-pay when rates are lower. These factors are currently moving in a positive direction for homebuyers.
Inflation has been a concern, but recent efforts by the Federal Reserve to raise interest rates have brought inflation down to around 3 percent. The Fed has not increased interest rates since July 2023, and market expectations now lean towards rate cuts rather than rate increases. Morningstar predicts substantial rate cuts by the Fed in the next few years.
The risk component of mortgages may also be coming down. Most mortgages are guaranteed by government agencies, so the risk for lenders is not that borrowers will default but that mortgages will prepay, reducing lenders’ returns. Falling rates create a virtuous cycle in which lower rates reduce prepayment risk, driving rates down further.
The Federal Reserve’s purchases of mortgage-backed securities (MBS) have also affected mortgage rates. The Fed’s holdings of MBS increased significantly in an effort to keep mortgage rates low after the financial crisis. However, the Fed is now working to downsize its balance sheet, which has contributed to higher mortgage rates. Economist Gerald Dwyer predicts that the sell-off will eventually taper, and the Fed’s holdings will naturally come off the balance sheet without being sold into markets.
While there is optimism for homebuyers, the real estate market remains in a slump. Many buyers and sellers are still on the sidelines. Freddie Mac notes that homebuyers have yet to respond to lower rates, and applications for new mortgages are still below spring levels. Current homeowners with low-interest mortgages have been reluctant to sell and buy new homes with higher interest rates. This has created a gap between buyers and sellers.
Overall, the prediction of lower mortgage rates and reduced risk premiums is good news for homebuyers. Cheaper financing may make buying a new home more affordable, while sellers may see more robust demand. However, there is still a lingering gap between buyers and sellers, with homeowners valuing their homes more due to their low-interest mortgages.
