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How Long Can Rates Stay This Low?

By: MortgageLoan.com
Posted: 3/31/2012 3:53:00 PM
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The sharp jump in mortgage rates last week put a scare into fence-sitters who've been thinking about buying a home or refinancing their mortgage. Fortunately, they eased back down again this week but the question remains: how long can mortgage rates remain this low? 

Mortgage rates have been stuck at mind-numbingly low levels for the past five months. According to Freddie Mac, last week was the first time that interest rates on a standard 30-year fixed-rate mortgage rose above 4 percent, only to slip back below this week.

 

Even so, it's clear that mortgage rates can't stay this low forever. It was big news when 30-year rates fell below the 5 percent mark in March 2009 - a level unimaginable just a few years before. Now we're a full percent lower than that. When you consider that rates rarely fell below 7 percent prior to 2001, and often ranged much higher, it's clear that rates will eventually move back toward more historical norms.

 

The question is, when will that happen - and what will trigger it?

 

Rates follow the economy

 

The simple answer is, when the economy improves - the housing market in particular. Last week's spike in interest rates was triggered by a flurry of positive economic reports. This week, rates went back down on news that housing prices were still weakening and small reversals in home sales trends.

 

Interest rates go up when the economy improves because there's more demand for borrowing money. Consumers are more willing to buy, businesses see more opportunities to invest. When demand for something goes up, so does the cost - which in the case of mortgages, are interest rates, which reflect the cost of borrowing money.

 

Inflation a trigger

 

A growing economy can also feed inflation, which drives up interest rates simply because rates need to be higher to offset the diminishing value of the dollar.

 

The Federal Reserve has indicated it will seek to keep interest rates low for the foreseeable future - but low is a relative term. Remember, 5 percent is low by historical terms - and the full-percentage point slide since early 2011 happened mostly without Fed intervention.

 

When rates start to move, they can change abruptly. One-month increases of four-tenths of a percent are not unheard of. Though a sudden return back to the 6 percent or 7 percent range seems unlikely, it wouldn't be at all surprising for rates to return rather quickly to the 5 percent-plus range, which is still low by historic standards.

 

Pent-up demand could spur rate increases

 

One thing to keep in mind with the current housing market is the matter of pent-up demand. With home sales at absolutely anemic levels the past three years, a lot of people who normally would have purchased homes are living in rental properties or even with their parents. Once these people start to feel more confident about 1) the security of their employment situation and 2) the stability of home prices, you could see them come into the home-buying market in a big way. That would not only push up mortgage rates, but would boost the economy as well, putting further upward pressure on rates.

 

No one can be sure what rates will do in the future. However, it's a pretty good bet they're not going to be much lower than they are right now and could be significantly higher. If you're sitting on the fence about buying a home or refinancing, don't count on mortgage rates to stay this low indefinitely or provide a clear signal that they're headed back up. You could find the opportunity for a really low rate has passed before you know it.