It is that time of year when we dust off our crystal ball and see what the mortgage industry might bring us for the coming year. And while no one can tell you what interest rates will do I can make some observations based upon economic progress in 2018 with recent Federal Reserve statements in mind. But before we make our bold predictions, how are interest rates set in the first place? That’s a good question and there is a concrete answer. Lenders don’t wake up in the morning and think about where they should price their rates based upon nothing more than a whim. Instead, rates follow a very specific set of indices. If you’ve always wondered how interest rate outlooks are determined, you’re about to find out.
How Will This Affect Me?
The most popular loan programs in the market today are conforming loans approved using Fannie Mae and Freddie Mac guidelines. And each business day, mortgage lenders refer to the current price of the appropriate mortgage bond and then set rates accordingly. Did you know there were such bonds? There are and the most commonly referred to index is the FNMA 30-yr 3.5 or 3.0 coupon. That symbol stands for the Fannie Mae 30 year interest rate yield currently being bought and sold by investors. Other such bonds are the FNMA 15-yr or the FHLMC 30-yr. Government-backed mortgages follow their own listed as GNMA 30-yr 3.5.
Like any other type of bond, the higher the price for the bond the lower the yield, or the interest rate on a mortgage. When demand for such bonds, any bonds for that matter, is high it drives up the price in a classic supply and demand model. Why do people buy bonds? They don’t invest in bonds in order to strike it rich but instead invest in bonds as a vehicle for safety. When an investor buys a bond the yield is known ahead of time. Even though the yield is small compared to say a rising stock price, it’s safety the investor is concerned about.
Okay, so when and why does an investor seek out safety? If an investor feels the economy is headed for a slowdown and stocks will pull back, the investor might take move some funds from the portfolio out of stocks and more into bonds until the investor thinks the economy is on an upswing and will then sell bonds and move more into stocks. When there is less demand for safety and investors feel more confident in the economy, the demand for bonds will shrink, causing the price to fall and interest rates to rise.
So what does our crystal ball tell us for 2018? Again, we’re not fortune tellers but as it relates to how the economy might look in 2018 we can look over the past 12 months to see where we’ve come from. So far, we’ve enjoyed a measured, positive rise in the economy as unemployment has fallen over time and more people are back to work. Other economic indicators also show a gradual improvement all the while keeping any inflation at bay. That said, we can expect to see fixed rates move upward at least through the first half of next year, anything beyond that and our magical crystal ball grows dark. At minimum, we really don’t see rates falling in any dramatic fashion as the Fed sits on its hands.