Why Rising Rates Aren't a Cause for Concern

Blog posted On February 27, 2018

Anyone who is in the market for a new home or considering a mortgage refinance is acutely aware of upcoming rate hikes in 2018.  After sustained economic recovery through quantitative easing, the Federal Reserve is on track to continue to gradually raise the benchmark interest rate.  After years of historically low interest rates, the expected rate hikes should not be cause for concern.  Just over a decade ago, the average mortgage rate was well over 6%, and twenty years ago, the average mortgage rate was nearly twice what it is today.  The coverage surrounding the impending rate hikes should not be misconstrued as negative.  Prospective home buyers looking to make a purchase or homeowners considering a mortgage refinance should know mortgage rates are still historically low, the Fed has had a long-term plan to restore interest rates since the Financial Crisis, and typically consumer confidence, low unemployment, and wage growth offset rising interest rates.

In 2008, the Federal Reserve lowered the benchmark interest rate to near-zero levels.  Since then, borrowers have grown accustomed to a low interest rate environment.  However, as recently as the early 1970s, when the Baby Boomers were starting to form their own households, the average mortgage rate hovered near 7.25%.  Heading into the 1980s, the Fed had to aggressively raise interest rates to keep up with overheating inflation.  By mid-decade, mortgage rates suffered, skyrocketing to a peak of almost 19%.   As inflation cooled, in the 1990s, mortgage rates dropped to more affordable levels.  Even if mortgage rates start to break 5% this year, it is unlikely that they will spike to the record-high levels they reached in previous decades.

To stimulate economic recovery, following the Financial Crisis, the Federal Reserve purchased treasury bonds and mortgage-backed securities.  This process is known as quantitative easing.  The Fed also lowered the benchmark interest rate, to facilitate responsible borrowing and lending.  This was never a permanent move and the Fed typically will raise interest rates as inflation picks up and the job market grows.  With inflation nearing the 2% target and the job market close to full employment, further interest rate hikes are expected.  Thus, any interest rate movement this year and beyond is just a reaction to other economic trends and will support the current economic environment, not greatly disrupt borrowing and lending. 

An end-of-year survey by real estate website Redfin.com found that only 6% of prospective buyers would cancel their plans to buy a home, if mortgage rates exceeded 5%.  42% of respondents would increase their urgency to buy, 27% would slow their search, and 25% would make no changes at all.   Based on historical data from the past 43 years, a 1% jump in mortgage rates has had a negligible impact on home sales in a strong economy.  In a weak economy, however, interest rate increases can occur alongside a slowdown in housing activity.  Today’s economic conditions are favorable for further interest rate hikes because of economic strength.  Unemployment is near a 45-year-low, consumers are confident, and most American workers have seen a wage increase from the tax reform earlier this year. 

Analysts are predicting between three and four federal interest rate hikes will take place in 2018.  Even after the three federal interest rate hikes in 2017, the average mortgage rate has climbed about a half of a percentage point.  Economic activity is gradual, and a federal interest rate hike will not lead to an immediate surge in mortgage rates, but rather a progressive increase.  Though three-to-four rate hikes may sound like it will trigger substantial movement, mortgage rates are likely to stay historically low. 

Sources: BBC, Bloomberg, Investopedia, Redfin, OCR