The myth of rising rates

By Samantha Peterson
Inman News

The predictions seemed to come from every direction, but the message remained the same: Interest rates for mortgages would come close, if not hit, 7 percent by the end of this year.

Now, more than halfway through 2004, it seems unlikely that interest rates will hit that 7 percent mark as originally predicted. Instead, they're still hovering around 6 percent, despite one hike in the federal funds target rate and another, which is widely expected to happen today. Perhaps the worry of significantly higher interest rates this year was simply a myth.

"In reality, (rates) declined in the first quarter, shot up during the second quarter and then came back down," said David Lereah, NAR's chief economist. "The bottom line is mortgage rates have been lower than expected, the economy is improving and jobs are being created in an environment of strong housing demand - all favorable factors for record home sales."

The Federal Open Market Committee meets today and is expected to raise the federal funds target rate by .25 percent, bringing it to 1.5 percent. The federal funds target rate is the borrowing rate banks charge each other overnight. Fixed mortgage rates tend to align closely with the 10-year Treasury bond, which generally reflects what the market is expected to do longer term, as well as any anticipated changes in the federal funds target rate.

Because of that, mortgage rates increased in anticipation of June's hike in the federal funds rate and didn't inch upwards after the actual announcement. In fact, they have declined since the announcement, and have not increased in anticipation of today's expected hike. That has kept housing sales brisk and has economists revising their original forecasts of an interest rate of about 7 percent by the end of the year.

A closer look at interest rates over the past 18 months reveals mortgage rates that have hovered in the very affordable 5 percent to 6 percent range and have deviated only slightly from that. Even the high end of that range - 6 percent - is a far cry from the rates of just a few years ago that were closer to 8 percent.

In January 2003, mortgage rates hit 5.92 percent, the first time below 6 percent in years, according to Freddie Mac's primary mortgage market survey. They continued dropping, eventually hitting 5.23 percent in June 2003. But the next month saw a spike up to 5.63 percent, followed by 6.26 percent in August.

The remainder of 2003, however, saw interest rates drop, though they didn't come close to hitting June's low. The year ended with 5.88 percent as the average fixed-rate mortgage in December.

The first three months of this year saw interest rates drop as well, eventually hitting 5.45 percent by March. But they then sprung back up: 5.83 percent in April, followed by 6.27 percent in May and 6.29 percent in June. That jump can be largely attributed to the anticipated hike in the federal funds rate at the end of June.

In July, the average was 6.06 percent and dropped further after last week's release of July payroll data.

Given those figures, will rates hit that 7 percent mark this year?

Some economists don't think so. NAR, for example, has already revised its economic forecast to predict lower than originally expected interest rates. As recently as June, the trade association had forecast that the fixed-rate mortgage could reach 6.9 percent this year. Now, it is forecasting that it will gradually rise to 6.4 percent in the fourth quarter.

David Berson, Fannie Mae's VP and chief economist, has said he believes mortgage rates will end the year well below 7 percent.

The Mortgage Bankers Association is in the same camp. Chief economist Doug Duncan said he expects mortgage rates between 6.5 percent and 6.75 percent by the end of the year. They're not likely to go higher than that this year, but could be lower.

"If economic growth slows significantly, rates will not reach that level but rather be between 6.25 and 6.5 percent," Duncan said. "The Federal Reserve will continue to raise interest rates a quarter point this meeting and once or twice more this year."

Some experts attributed a surge in home-buying activity over the past few months to a rush to get into the market before rates continued their expected upward climb. They still predicted a banner year for real estate sales, but those expectations appear to be even more likely given the reasonable expectation of continued low mortgage interest rates.

Toss in the upcoming presidential election and no one is eager to see rates climb significantly higher and risk raining on the housing parade of the past few years. Instead, most will be happy to concede that higher interest rates this year were simply a worry and nothing else.

Second Mortgage News