Between 2H2018 and 1H2019, something funny happened. The Federal Reserve was raising their Fed Funds rate, yet mortgage rates kept on falling. This article explains why are mortgage rates falling after the Fed starts raising rates. Hint: The Fed is not always right.
Even though the Fed has slashed rates to 0% – 0.125% due to the pandemic, let's study what happened in the past.
Today, the Fed is aggressively raising the Fed Funds rate to combat elevated inflation. However, after the bank runs at Silicon Valley Bank and Signature Bank, mortgage rates started falling as well.
Below is a case study from the best.
Why Are Mortgage Rates Falling After The Fed Started Raising Interest Rates?
Despite the Fed raising interest rates methodically since late 2015, mortgage rates have actually gone nowhere during this time period.
First, let's look at the Fed Funds rate chart since end of 2015. The hikes have been steady and quite steep based on where we came from.
Now let's look at various mortgage rate terms since 2015. Notice how the average mortgage rates for a 30-year fixed, 5/1 ARM and 15-year fixed are all back to where they were at the end of 2015.
Why aren't mortgage rates increasing along with the rise in the Fed Funds rate?
The simple answer is that the Fed does not control mortgage rates. The bond market via bond investors do.
The Federal Reserve sets the overnight lending rate (Fed funds rate), which determines how expensive it is for banks to lend money to each other on overnight transactions.
This short-term rate helps determine money market rates, checking account rates, short-term CD rates, and even egregious credit card rates. For example, you can now get a healthy money market rate whereas back in 2015, the best you could do was around 0.25%.
Mortgage rates, on the other hand, are influenced by the 10-year US Treasury bond, which is determined by the market, not the Fed.
So What Do Low Interest Rates Mean For Investors?
On the one hand, low bond yields mean that the opportunity cost for not holding bonds is low. Therefore, investors are more inclined to invest in stocks, especially if the S&P 500 dividend yield is higher than the 10-year Treasury bond yield.
Just imagine if the 10-year Treasury bond yielded 10%. You may not be inclined to risk as much money in the stock market because the 10% is a guaranteed annual return if you hold the 10-year bond to maturity.
That said, if the 10-year bond yield is at 10%, it likely means there is rampant inflation due to massive wage pressure and accelerated corporate earnings. In this scenario, stocks may very well return much greater than a risk-adjusted 10% a year.
Declining mortgage rates also means more people can afford homes. The real estate market is unlikely to collapse under a wave of mortgage defaults because the credit quality of mortgage borrowers has drastically increased since the financial crisis.
The average FICO score for an approved mortgage is over 720, and you no longer have NINJA loans that don't require any money down. Those adjustable rate mortgages that are resetting today aren't going to see a large uptick at all.
Higher Mortgage Rates Today Due To High Inflation
Meanwhile, homeowners who missed the massive refinance window before November 8, 2016, had a huge window of opportunity to refinance in 2020 and 2021. Whether you took out a 30-year fixed mortgage or the preferred adjustable rate mortgage, you were winning.
Based on mortgage by interest rate, 90% of mortgage holders have rates below 5%. As a result, fewer people will be selling homes to trade up or down.
On the other hand, investors should be a little worried that despite all signs pointing to a healthy economy, so many investors are choosing to buy US Treasury bonds for only a ~2.2% annual yield. The logic goes, if the economy is so awesome, why wouldn't you sell bonds and buy as many risk-assets as possible to get as rich as possible? What does the bond market know that we do not know?
The answer lies in still benevolent inflation figures and FEAR. Anybody who has been investing for the past 20 years or longer has seen boom bust cycles come and go. Everything seemed hunky dory in 2007 when the unemployment rate hovered at only 4.5% and the S&P 500 consistently returned double digits for years. Then everything fell apart.
Refinance When You Can
You never know when sentiment will turn, but when it does, the fall is always quicker than the rise due to the fear of losing everything. Low interest rates means more leverage.
More leverage means more violent destruction on the downside. Therefore, it's better to sell risk-assets in an appreciating market. Even though you won't catch the top, it's much better than trying to sell in a declining market when the demand floor drops out from under you.
Stocks, bonds, cryptocurrencies, and coastal real estate are all expensive today. As a result, I'm not adding to any of my positions at the moment, but instead, deleveraging by paying down mortgage debt and raising my cash balance.
Further, pay attention to mortgage market anomalies. Right now, it's much better value to refinance into a 30-year fixed or 15-year fixed mortgage. The rates are lower than ARMs.
Diversify Your Investments
My immediate goal is to take profits in one of my SF rental properties and redeploy the proceeds into cheaper middle America real estate. Real estate rose to ~40% of my net worth after I purchased another home in 2014, and I'd like to get the figure down to a more conservative 25%.
My favorite real estate crowdfunding platforms are Fundrise and CrowdStreet. Real estate prices and rental prices should continue to do well because mortgage rates will stay low. Further, the demand for property has gone way up since we're all staying at home longer.
I've personally invested $810,000 in real estate crowdfunding to diversify my San Francisco holdings. Further, I want to make more 100% passive income from higher rental yield properties in the heartland.
The work from home trend is here to stay post-pandemic. Therefore, more money will be going into real estate. This is especially true after stocks have performed so well.
Mortgage Educational Takeaways
- Ignore people in the real estate industry who say, “Buy now before interest rates get too high!” or “Refinance now because interest rates are rising!” They don't understand interest rate fundamentals.
- If the short end of the yield curve (Fed funds rate) rises faster than the long end (10-year bond yield), the yield curve will flatten. A flattening yield curve means investors are not being compensated for holding longer-term securities largely due to muted inflationary expectations and greater fear of the future. A flattening yield curve can sometimes be a signal for an upcoming recession.
- Pay attention to national inflation and unemployment rates. These are the two figures the Fed focuses on the most. The Fed targets an unemployment rate of between 4.7% – 5%, and an inflation rate of 2%. If inflation comes in much higher than 2%, the Fed will have a tendency to raise interest rates more aggressively.
- Never confuse brains with a bull market. Arrogance is wealth-destroying. Try not to fight the Fed or the government either. The Fed wants to enrich asset owners at the expense of non-asset owners. The government, with its pro-housing rules, wants every American to own a home. I've personally invested $810,000 with real estate crowdfunding to take advantage of much cheaper real estate away from the coasts.
Recommendations To Build Wealth: Buy Real Estate
If you don't have the downpayment to buy a property, don't want to deal with the hassle of managing real estate, or don't want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It's free to look.
Shop around for the latest mortgage rate. Check the latest mortgage rates online. You'll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the better. This way, you feel confident knowing you're getting the lowest rate for your situation. Further, you can make lenders compete for your business.
Why Are Mortgage Rates Falling is a FS original post.