The Federal Reserve (the Fed) has been driving down interest rates–particularly mortgage interest rates–by purchasing $45 billion worth of U.S. Treasuries a month and $40 billion worth of mortgage-backed securities (MBS) per month.
Mortgage-backed securities are essentially debt borrower by institutional lenders (such as Fannie Mae and Freddie Mac) to fund the purchase of mortgages. By purchasing these securities the Fed drove down interest rates paid by the institutional lenders, hoping that it would show up in interest rates in mortgages, thus reducing housing costs to consumers, freeing up disposable income, and inducing consumer spending to boost the economy. Most analysts agree that it worked.
Recently it came out that the Fed’s demand for mortgage-backed securities was larger than the supply – the Fed was trying to buy more securities than were being offered, because of the dramatic slowdown in the mortgage market since April of 2013.
Today the Board of Governors of the Federal Reserve announced that they would begin to taper their purchases, reducing monthly purchases of Treasuries and MBS’s by $5 billion each.
Per Greg Robb, of MarketWatch.com: “Starting in January, the Fed will reduce the pace of asset purchases to $75 billion from $85 billion a month. And if the economy improves at the pace the Fed expects, outgoing Chairman Ben Bernanke said in a press conference that he could foresee the bond-purchase program coming to an end by late next year.”[i]
“The Fed said it moved because it had greater confidence in the (economic) outlook.”
The other tool the Fed uses to prime the economic pump is by charging banks very low interest rates for short-term borrowing, something they intend to keep in place for now. “In an effort to keep market rates stable, the Fed stressed that it will be in no hurry to raise short-term interest rates. The central bank added new language that it plans to maintain the target Fed funds rates “well past the time that the unemployment rate declines below 6.5%.”
How will this impact mortgage rates?
We’ve known for a while that the taper would happen, just not when. We’ve also known that interest rates were rising. In addition, little-known fees charged by Fannie Mae and Freddie Mac will be increased pretty dramatically next year. This move will raise hundreds of millions of dollars for the Treasury without having to increase taxes, but it too will put upward pressure on interest rates. In essence they will be taxing mortgages.)
Finally, the Federal Housing Finance Authority (FHFA) which oversees Fannie and Freddie, are making other moves to reduce the role of the government-sponsored entities in mortgage lending. I’ve written about some of these other moves in previous blogs.
As the government backs out of its role in providing affordable mortgage financing so that private enterprise can step in, rates will surely rise.
So, this is it. We’ve known it’s been coming, we’ve seen it coming, and now it’s here. I predict that you will see mortgage interest rates rise unsteadily throughout the coming year.
My name is Casey Fleming, and I originate mortgage loans throughout California. I am based in Silicon Valley.
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