Who Cares What Rates Do?

Orion does! Many of our brokers ask how mortgage interest rates are determined, and why they’ve come down (again) in the first quarter, and now into mid-May. Plenty of experts forecast that rates would climb in 2019, and they didn’t. In fact they fell, much to the benefit of Orion’s broker’s clients. The quick answer about how rates are sit is that supply and demand set prices: the higher the prices, the lower the rates. But what determines supply and demand?

The supply side of the equation is determined by the amount of mortgage originations there are. The latest from the MBA indicates a $2.4 trillion year for 2020. Demand is determined by investors’ expectations of what will happen in the economy in the future. If investors think there will be inflation, they will require a higher rate of return, demand will shrink and rates will go up. The more detailed answer is the value of the investment is determined by the rate of return. Lenders usually do not keep their mortgages but rather bundle them into huge pools and sell them to Fannie/Freddie/Ginnie. By selling the mortgages the lender reloads on cash, which they then use to fund more mortgages.

In general, the demand for any fixed-income security will be based on future inflation expectations. As we head toward the end of May and into summer, inflation is the last thing on anyone’s mind. In addition, risk matters: the riskier the asset, the higher rate they’ll have to pay. Is a particular borrower a better credit risk than IBM, or Coca Cola? If they are, then they’d pay a lower rate. Investors are willing to forego some profit for the stability of the investment, but they put their money in depending on their best guess as to what will happen in the future and how they can maximize their return.

For the past several years the Federal Reserve has been impacting the demand side of supply and demand by purchasing billions of dollars of mortgages. Previously QE (Quantitative Easing) policy intended to drive interest rates low and assist the housing market in recovering from the collapse. It worked. The recent decline in rates is helping our brokers, and is mostly based on speculation that the coronavirus will negatively impact worldwide economies and that the Fed may consider lowering rates again. This will alter the demand for mortgages; less demand with constant supply will drop prices. To summarize, investors speculating on supply and demand and the future economic conditions determines interest rates, including your mortgage!

But low rates and COVID also mean that people are staying in their homes longer. Falling mortgage rates can help incentivize homeowners to sell their home and purchase a different home, but persistently low mortgage rates can have the opposite effect.

Because many of your existing clients either bought property when rates were low or took advantage of the recent dip in rates to refinance, they are now sitting comfortably with historically affordable mortgages. That could make them less likely to move because it’s unlikely they’d see much financial benefits in the form of a cheaper mortgage, meaning the choice to move will be driven by other factors such as higher income or an expanding family.

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