By Brad Walker, CEO of Income&
The conundrum of why mortgage rates continue to slip months after the Federal Reserve raised the prime rate is just one of the perplexing economic puzzles the Governors of the Federal Reserve are going to have to figure out as they try to “normalize” the US economy.
No matter what steps the Fed takes, it’s becoming increasingly evident that years of ultra-low interest rates and accommodative policy can’t just be dialed back. Financial markets have been “hooked” on easy money for a long time, but the individual buyers and sellers that comprise the markets apparently need to see more than they’ve seen so far to believe the economy is revving up. Moreover, a substantial and growing number seem to believe that sluggish two-percent or so economic growth is becoming the “new normal” for the US.
Fed Raised Prime Rate Last December, but Have Held Off on Further Increases
The Fed finally pulled the trigger on a rate hike back in mid-December of last year. This was the first time the Fed had boosted the prime rate since the 2008 financial crisis. Most economic pundits thought that the modest .25% hike was just the first in a series of rate hikes that we would see over the next several quarters, but given mixed economic data, the Fed has not taken any further action this year.
Given the current uncertainty about more prime rate hikes and the economy in general, mortgage rates have not budged. In fact, 30-year mortgage rates fell for four straight weeks shortly after the holiday rate hike last year. The average rate for a 30-year mortgage in the US has continued to edge down and stands at 3.52% as of July 7th.
Understanding the Prime Rate and Mortgage Rates
The key to understanding this financial conundrum is remembering that the Fed “raising rates” does not mean central bank officials just push a button and interest rates move up. All the Fed can do is change the rate at which it loans money to financial institutions. It’s up to the banks and other financial institutions to decide what to do then. Some banks may pass on that interest rate increase to loans they make to business and consumers, others may choose not to or to increase rates selectively.
Another important consideration is that consumer loans or business loans are not the same as mortgage loans. Unlike most business and consumer loans, a mortgage loan is secured by the value of the home and the property it sits on. This means that mortgage loans are inherently less risky than non-secured loans, which means the interest rate for the loan can be lower.
What it boils down to is that mortgage rates are not directly connected to the prime rate. In fact, given that mortgages are long-term loans, mortgage rates historically tend to mirror the movement in the bond markets, especially longer-dated bond prices.
As a number of financial industry pundits have pointed out, mortgage rates won’t start moving up until prime/consumer interest rate increases have become a notable trend, and we actually see longer-term interest rates start rising again. This, of course, means that there is not likely to be much upward movement in mortgage rates until we see a series of prime rate hikes from the Fed.