Mortgage rates have been at an all time low during the years following the economic downturn caused by the COVID-19 pandemic. However, the reopening of the economy has increased certainty and consumer confidence, and now mortgage rates are expected to increase from their historic lows. Some expect mortgage rates to increase by the end of the year, while more optimistic experts predict the rates will stay steady for the remainder of the year. To have a good idea on when mortgage rates will increase, it helps to understand what causes them to change.

There are two types of mortgage rates: Fixed mortgage rates and variable mortgage rates. As the name suggests, fixed mortgage rates stay unchanged throughout the life of the loan. On the other hand, variable mortgage rates increase or decrease depending on a benchmark interest rate or index.

Fixed mortgage rates

Fixed mortgage rates are affected by the yield on 10-Year Treasury bonds. When there is economic uncertainty, there is a greater demand for safer investments such as Treasury bonds. These bonds are considered safer because the government will repay you no matter what. The greater demand for Treasury bonds drives up the prices of the bonds. There is an inverse relationship between the price of bonds and their yield. When the price goes up, the yield goes down and vice versa. Lastly, if the yield of the bonds goes down, mortgage rates will typically go down as well.

This explains the fall in fixed mortgage rates during the COVID-19 pandemic. Since there was a lot of economic uncertainty, unemployment and loss of consumer confidence, investors turned to treasury bonds. The higher demand in the 10-Year treasury bonds translated into a lower yield and therefore a lower fixed mortgage rate.

Looking forward, as the economy reopens with the rollout of the vaccines, there is more certainty and consumer confidence. This means that the demand will slowly decrease, the price of Treasury bonds will fall and the yield together with mortgage rates will increase. There has already been an increase of 0.4% since the beginning of the year, according to Freddie Mac. Different experts have different forecasts on how much the mortgage rates will have risen by the end of 2021. Some say that the mortgage rates can remain as low as 2.875%, while others predict rates will rise to 4.25% for a 30-Year fixed rate mortgage.

Variable mortgage rates

 The variable rates lenders set on the mortgages they offer are based on an underlying benchmark interest rate or index. This interest rate is usually the Prime Rate. The prime rate is the mortgage rate that lenders offer to their most creditworthy customers. It is impacted by the Fed Rate because the prime rate is typically 3% higher than the Fed Rate. The Fed Rate is set by the Federal Reserve and it determines the rate at which banks and lending institutions can borrow or lend to one another in the short term.

There are two ways in which the Federal Reserve has kept interest rates low so far. First, by setting a low benchmark interest rate or low Fed Rate. In March 2020, the Federal reserve set a benchmark interest rate of 0% – 0.25%. When the Fed Rate is low, it means that it is cheaper for banks to borrow from one another. The reverse is true, when the Fed Rate is high, it is more expensive for banks to borrow. Therefore, in this case of a low Fed Rate, banks translate the lower costs to the borrowers by setting lower variable interest rates. The variable interest rate decreases as the Prime rate decreases, as we mentioned earlier, it is usually 3% above the Fed Rate.  Fed policymakers expect to make 2 interest rate increases by the end of 2023.

The second way the Federal Reserve impacts the variable mortgage rates is by purchasing Mortgage Backed Securities. Eventho, lenders are the ones who give out mortgages, they usually don’t keep them. They rather sell them to investors who pay more for these mortgages and in this way the lender makes a profit. When there is economic uncertainty, MBS and Treasury Bonds are a safer investment choice. Therefore, with the economic uncertainty caused by COVID-19, the demand for MBS increased, making the price of MBS increase. When the price of MBS increases, mortgage lenders make more money, and therefore lower variable interest rates. The Federal Reserve has been purchasing MBS in bulk with the economic downturn. However, it is expected that it will slow down the purchasing soon, probably even before changing the Fed Rate.

In conclusion, even though mortgage rates are expected to increase, most predict that the rates will stay stable for the remainder of 2021 and might increase slightly from the all time low of 2.65%. A higher increase will probably be seen in the years following as Fed policymakers make the 2 interest rate increases. Therefore, if you are looking to purchase a home through a mortgage or refinance your current mortgage at a lower rate, now is the time to do so.