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The Federal Reserve's (Fed’s) June rate hike pause is likely to impact the mortgage market.
The pause follows a series of ten consecutive rate hikes in 2022 and 2023 as part of the Fed's aggressive stance against inflation. In its latest meeting, the Fed announced no further increases in the federal funds rate, at least for the time being – with potentially two more 25 basis point hikes planned before the end of 2023. The broader economic context suggests that the pause may be temporary, with the Fed remaining committed to its goal of reducing inflation to a 2 percent benchmark.
This possibility of future rate hikes, coupled with the current pause, creates a complex landscape for potential homebuyers, homeowners looking to refinance, and sellers alike.
Given the Federal Reserve's continued focus on inflation control, some economists predict that mortgage rates could drift down over the year's second half.
The Fed and Mortgage Rates
The Federal Reserve does not directly set mortgage rates, but its decisions and policies do influence the broader economic environment in which these rates fluctuate.
Mortgage rates are closely tied to 10-year Treasury yields, which are indirectly influenced by the Fed's actions. During the rate hike spree in 2022, the Fed's policies resulted in an escalation in mortgage rates, jumping from 3.4 percent in January to a high of 7.12 percent in October, for example. The 30-year-fixed mortgage rate today sits around 6.7%, according to the FRED, up from around 5.54% in June last year and significantly higher than the 3% rates found in June 2021.
*Source: Freddie Mac, 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MORTGAGE30US, June 18, 2023.
While the rates have shown slight downward movement from their recent peak in 2022, the current rates are still significantly higher than at the beginning of the rate hikes.
Impact on the Housing Market
The rapid rise in interest rates during the past year has had a cooling effect on the housing market. High-interest rates make it more expensive to finance a home purchase, lowering buyer demand, leading to slower sales and potentially softer prices. Yet, it's essential to acknowledge that the housing market is influenced by a mix of factors, including economic growth, unemployment rates, and population trends, making it hard to isolate the impact of interest rates alone. US home prices have increased significantly since COVID-19 started, but now they're starting to come down again.
Looking at history can offer some perspective. The housing market has been resilient even in high-interest-rate environments. For example, in the 1980s, when mortgage rates reached unprecedented levels of up to 18 percent, and during the 1990s, with rates hovering around 8 to 9 percent, Americans continued to buy homes.
These historical precedents suggest that the recent slowdown in the housing market may be a reversion to a more balanced market rather than a signal of a significant downturn. Nonetheless, the higher rates have reduced affordability, particularly impacting first-time buyers and those with lower incomes. As such, both potential buyers and current homeowners must consider their options carefully in this high-rate environment.
*Source: U.S. Census Bureau and U.S. Department of Housing and Urban Development, Median Sales Price of Houses Sold for the United States [MSPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/MSPUS, June 18, 2023.
Effects on Mortgages Purchases
In the wake of the Fed's rate hike pause, new mortgage rates will likely have some influence. Given the potential for economic slowdown and the Federal Reserve's continued focus on inflation control, some economists predict that mortgage rates could drift down over the year's second half.
However, potential homebuyers must remain aware that even with a downward drift, rates remain considerably higher than they were at the start of the rate hike sequence. Therefore, the costs associated with financing a home purchase will still be steeper than in the low-rate environment seen in the past years.
US home prices have increased significantly since COVID-19 started, but now they're starting to come down again.
Impact on Refinancing
The impact of the rate pause on refinancing is worth noting. As interest rates have increased over the past year, refinancing activity has substantially decreased. Homeowners who might have looked to refinance to take advantage of lower rates are now facing a more costly prospect. With the current pause in rate hikes, some homeowners may hope for a downward rate trend before deciding to refinance, but if they need to refinance in the next year, they will likely be in for a shock increase in costs. As with new mortgages, potential refinancers should be prepared for the possibility that rates may still increase later in the year, and may stay higher for longer.
Potential Strategies for Borrowers
In this high-rate environment, potential borrowers need to be strategic. Shopping around for a mortgage is one of the most effective strategies, as it can uncover lenders willing to offer more competitive rates and fees. While the appeal of adjustable-rate mortgages (ARMs) may be tempting in light of their initial lower rates, borrowers should be cautious. The risk of higher rates in future years may outweigh any initial savings, particularly as new adjustable mortgage products are structured to change every six months, increasing the potential for rate hikes.
Moreover, homeowners looking to tap into their home equity might consider home equity lines of credit (HELOCs) instead of refinancing. While HELOCs might have higher rates, they can access home equity without disturbing the original, lower-rate mortgage.
Conclusion
While the Federal Reserve's decision to pause rate hikes may provide a temporary reprieve in the upward trend of mortgage rates, it's essential to remember that we remain in a high-rate environment compared to previous years. Furthermore, the possibility of rate hikes resuming later in the year looms, adding an additional layer of uncertainty. Navigating this complex mortgage landscape requires staying informed about economic trends, exploring various borrowing options, and remaining proactive in financial planning. Now more than ever, a prudent approach to mortgage decisions is the key to achieving financial stability and success in homeownership.
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Matthew is a freelance financial copywriter with 14+ years in financial services. He holds a Bachelor of Science degree in Economics with business and finance options and is a CFA Charterholder. He is from Vancouver, Canada, but writes from all over the world.
