Mortgage interest rates may not go up, housing may prosper in 2016

The federal reserve raised the federal funds rate, but that doesn’t mean mortgage interest rates must rise.

The future of housing in inexorably tied to the course of mortgage interest rates. If mortgage rates remain below 4.25%, both house prices and sales volumes will be higher in 2016 than 2015. An improving economy, strong job growth and rising wages are a recipe for a healthy housing market. Unless rising rates spoils the party, 2016 will be a good year.

Does that mean there’s no reason to worry? Hardly. The federal reserve is raising interest rates, and although this doesn’t necessitate higher mortgage rates, it certainly encourages them. Higher mortgage rates will harm sales, and if rates rise high enough to make Coastal California housing unaffordable, prices might go down again.

Rate Hike no Concern for Freddie’s Chief Economist

Jan 4 2016, 1:00PM

Freddie Mac is dismissing concerns of some analysts that the change in the Federal Reserve’s monetary policy may bode ill for the housing industry.  The company’s vice president and chief economist Sean Becketti welcomed the New Year with an upbeat rebuttal of those concerns. …

Further, the connection between short-term rates controlled by the Fed and long-term rates including those for mortgages is “tenuous.”  He cites the example of the 17 consecutive monthly rate hikes made by the Fed in the mid-2000s.  They had virtually no effect on mortgages rates which remained around 6 percent.


The chart above is the most important piece of financial history concerning housing this year. We’ve seen this play out before when the federal reserve raised interest rates in 2004. Mortgage rates were nearly unchanged despite a 4% increase in the federal funds rate. Will it be the same this time around?

The weak global economy will continue to attract money to Treasury securities from around the world, limiting longer-term interest rates while the strong dollar and falling oil prices will hold U.S. inflation down.  This will provide further incentives for the Fed to only gradually and cautiously increase monetary tightening.

Becketti does see long-term rates beginning to move up this year as monetary tightening starts to impact economic activity but those rates will move only fractionally compared to short-term rates.  However, he says, even a modest increase in mortgage rates will cut home affordability, especially for first-time and low-to-moderate income homebuyers and this may restrain house price increases at the lower-priced end of the market.

This is where it’s important to separate Coastal California from the rest of the country. Where we are the restricted inventory pushed prices up to the limit of affordability. The rest of the country has lagged well behind Coastal California in this regard. Higher interest rates will be immediately felt here, but in 90% of the country, it won’t make much difference at all.


This could change should the Fed begin to reduce the size of its mortgage-backed securities (MBS) portfolio obtained through the various quantitative easing (QE) programs. This could drive long term rates up sharply but the concept is at odds with the Fed’s public commitment to gradual easing.  “We don’t expect the Fed to shrink the QE portfolio until the latter part of 2016 at the earliest, and any significant reduction in the QE portfolio isn’t likely until 2017,” he says.

This is what will impact mortgage rates. Right now, the federal reserve is still quantitative easing because it’s investing the principal repayments from it’s mortgage-backed securities pool back into the mortgage debt markets, keeping prices high and interest rates low in the process. When they stop reinvesting this money, mortgage interest rates will start to rise.

In the meantime, the cost of ownership relative to rent is still favorable for owning — even in Coastal California. Both rents and house prices are too high relative to income, but that’s a problem of overall supply, and it’s not going away any time soon. I believe the economy will improve this year, and rents will continue rising, making home ownership even more attractive.

What should you do if mortgage rates stay low for a very long time?

Accept the mechanical advice in my reports and believe that today is a very good time to buy a house. Winter is always a good time to shop as there are fewer competing buyers and sellers are generally more motivated.


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