Mortgage rates plumbed new depths in December and January, setting all-time lows south of 3 percent. Rates have climbed since then, and their trajectory for the rest of the year depends on the strength of the economic recovery.
That’s according to Greg McBride, CFA, Bankrate chief financial analyst. With coronavirus vaccines now widely available, there’s new optimism about the U.S. economy.
“Bond yields and mortgage rates have climbed since the beginning of the year but now reflect pretty lofty expectations for economic growth,” McBride says. “If economic reality doesn’t live up to expectations, rates are likely to pull back.”
Housing economists say the growing optimism is putting upward pressure on rates. The Mortgage Bankers Association, for instance, expects rates to reach 3.6 percent by the end of 2021. Its forecast three months ago called for rates to hit 3.5 percent in late 2021.
Fewer refis, more purchases
If rates continue to trend upward, the refinancing boom of 2020 will slow dramatically by the second half of 2021, says Michael Fratantoni, chief economist at the Mortgage Bankers Association.
“We think refi volume is going to fall off pretty sharply, particularly in the second half of 2021 as the economy really finds its footing,” Fratantoni says.
While mortgage rates will rise enough to discourage refinancing, they’ll remain low enough to make homebuying attractive, Fratantoni says. He predicts record mortgage volumes in 2021.
“Even if mortgage rates are going to be high enough to curtail refi, they’re still going to be low enough to keep housing affordable,” he adds.
How the Federal Reserve affects rates
The Federal Reserve doesn’t directly set mortgage rates, but the central bank does set the overall rate environment. The Fed slashed rates when the coronavirus recession began, and it has signaled that it will keep rates low for years, which will translate to little upward pressure on mortgage rates.
“I think the Fed is going to keep their foot on the gas, keeping short-term rates at essentially zero through 2022, and only very slowly begin to raise rates in 2023,” Fratantoni says.
While the federal funds rate doesn’t directly affect mortgage rates, there is a strong correlation between the rate on 10-year Treasury bonds and the 30-year mortgage. That spread widened in the spring and summer.
The typical gap between the 10-year government bond and the 30-year fixed-rate mortgage is 1.5 percentage points to 2 percentage points. During the scary early days of the COVID-19 pandemic, that spread rose as high as 2.7 percent. However, the gap has returned to normal.
Generally, an improving economy correlates to rising mortgage rates. Economists and investors think the U.S. economy will bounce back in 2021 as COVID-19 vaccines are distributed. However, it’s unlikely that mortgage rates will soar, McBride says.
“If the 10-year Treasury yield blows through the 2 percent mark, then expect the Fed to take some action to corral long-term rates, like shifting more of their bond purchases into longer maturities in an effort to bring things like mortgage rates lower,” McBride says. “Higher rates because of brighter economic prospects are one thing, but higher rates that begin to restrain economic growth are what they want to avoid.”