The Fed and Home Loans: Why Mortgage Rates Fell
This month, the Federal Reserve System hiked rates for the first time in nine years. In the days since the Fed move, mortgage rates actually dropped.
How is this possible? And will this trend hold as home-buyers make plans for 2016?
Immediate Mortgage Rate Reaction to Fed Meeting
Most U.S. mortgage loans up to $417,000 are packaged into bonds called Mortgage Backed Securities (MBS), and these bonds trade daily in global markets.
Throughout each day, mortgage rates fall when MBS prices rise, and mortgage rates rise when MBS prices fall.
Mortgage rates rose as investors sold MBS ahead of last week's Fed meeting. It was widely expected the Fed would hike the short-term Fed Funds Rate, but without knowing how the Fed might position 2016 rate policy overall, MBS investors took the conservative stance of selling ahead of the meeting.
Then when the Fed meeting announcement actually came out, the Fed said it was only hiking the Fed Funds Rate by .25 percent, and will take a "gradual" approach to tightening rate policy from here.
Bond markets reacted positively, and MBS buying resumed, pushing mortgage rates down.
Mortgage Rate Outlook Based on Revised Fed Policy
Now markets are estimating the "gradual" Fed Funds Rate hikes will happen about four times in the next year, for a total of about one percent.
The Fed Funds Rate is intended to influence broad rate markets overall, but not necessarily to have a direct impact on mortgage rates.
For example, the last time the Fed lifted Fed Funds was from June 2004 to July 2006, when the rate went up a total of 4.25 percent. During that same period, 30-year fixed mortgage rates only rose 0.5 percent.
As such, if 2016 estimates call for Fed Funds to rise one percent, mortgage rates probably won't rise by that full amount. However, there is one other element of Fed policy that does directly impact mortgage rates.
In response to the financial crisis, the Fed started buying MBS in January 2009 in order to push up MBS prices and keep mortgage rates down. In recent years, they slowed their highly aggressive MBS buying, but still buy enough MBS to influence mortgage rates.
The recent Fed statement reaffirmed a plan to continue this MBS buying during the Fed Funds Rate hiking cycle. This eased MBS market concerns, and should prevent a sharp spike in mortgage rates.
What Higher Mortgage Rates Mean for Home Buyers
Given all these factors, market estimates call for mortgage rates to rise about 0.5 percent by mid-2016.
A Zillow survey just showed that 70 percent of current home shoppers wouldn't be deterred by rates rising this amount, although 45 percent of these shoppers said they might scale down their price range.
The survey also showed that if rates rose 0.5 percent, the monthly mortgage payment on the median home in 19 percent of the country's top 500 metropolitan areas would increase by less than $25 a month. However, buyers in high-priced markets such as San Francisco and San Jose would see a monthly payment increase of $175.
Additionally, the Mortgage Bankers Association predicts mortgages for purchases will increase by 10 percent in 2016, so rates will certainly impact -- but shouldn't derail -- your home buying plans for the new year.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow or AOL Real Estate.