: ‘The era of sub-3% mortgage rates may be behind us’: The Fed’s policy shift could have major repercussions for home buyers

Additionally, the Fed signaled that an interest-rate hike could come sooner than expected in 2022.

“The forward guidance was pretty close to the most explicit that could realistically be expected,” Stephen Stanley, chief economist at Amherst Pierpont, wrote in a research note analyzing the Fed’s statement.

As part of the stimulus program, the Fed has purchased $40 billion worth of mortgage-backed securities each month. These purchases have pumped tons of liquidity into the mortgage industry, allowing lenders to drop interest rates to historic lows.

“The Fed’s aim was to maintain liquidity in the housing finance environment,” said George Ratiu, manager of economic research at Realtor.com. “I think it has absolutely achieved that goal.”

But reducing that bond-buying activity could have major repercussions for the mortgage industry — and the housing market.

Where will mortgage rates go now?

For the past two months, mortgage rates have essentially been in a holding pattern as investors waited for clearer signs of the economy’s trajectory. Interest rates on home loans have remained below 3% since July — and for most of this year they have stayed below that threshold.

As of Sept. 23, the 30-year fixed-rate mortgage averaged 2.88%, while the 15-year fixed-rate mortgage averaged 2.15%, according to Freddie Mac FMCC, +0.01%. The average rate for a 5-year Treasury-indexed hybrid adjustable-rate mortgage was 2.43%. “Mortgage rates have thus far held firm following the Federal Reserve’s statement,” said Matthew Speakman, senior economist at Zillow Z, -4.05% ZG, -3.40%. “The muted response by rates suggests that investors were anticipating the news, and the announcement aligned with their expectations.”

That could change in the coming weeks, though. “The moment the Fed starts pulling back, they will have an immediate effect,” Ratiu said. But even before the Fed takes action to scale back its mortgage bond-buying efforts, mortgage rates could rise.

Mortgage rates historically follow the direction of long-term bond yields, including the 10-year Treasury note TMUBMUSD10Y, 1.449%, though the relationship between the two has weakened at points throughout the coronavirus crisis — perhaps a reflection of how influential the Fed’s asset purchases have been. Long-term bond yields increased in reaction to the Fed’s statement, as investors began to price in the policy shift.

And so long as the economic recovery remains steady, investors’ appetite for bonds will be diminished, because they are viewed as a safe haven. That in turn would cause rates to rise.

“Though mortgage rates may go up a bit on this news, it’s more likely we’ll get a hop than a leap — and it may just be short term,” said Kate Wood, home and mortgage writer at personal-finance website NerdWallet.

“The Fed’s announcement really just says they intend to do things we already knew they were planning to do,” she added. “They haven’t laid out a schedule for tapering asset purchases, they’ve simply indicated that when they feel the time is right, they’ll do so.”

But when the Fed does take action, how high could rates go? “Rates are not likely to shoot up toward 5% anytime soon,” Ratiu said, because investor demand for mortgage-backed securities remains strong, which puts a ceiling on rates. He projects that mortgage rates will approach 3.5% by early 2022 and could be approaching 4% by the end of next year.

“The era of sub 3% mortgage rates may be behind us already by the end of this year,” Ratiu said.

How higher mortgage rates would affect the housing market

An increase in mortgage rates would almost surely cause a drop in the demand for refinancing, but the impact on home buyers and the housing market may be less apparent.

“Rate increases could dampen demand for housing, but it may be hard to distinguish between buyers discouraged by higher rates and those who’ve given up the home search due to rising home prices and lack of inventory,” Wood said.

Home prices are still rising — albeit not at the breakneck pace of earlier this year. The inventory of homes for sale remains extremely low, and home-builders continue to grapple with supply and labor shortages that are extending the timeline for new-home construction.

So while the white-hot housing market may only be red-hot nowadays, rising mortgage rates could still create significant affordability challenges for buyers.

“If prices remain at the same level and just move sideways, we’re likely to see the mortgage payments, as a share of income, you know, move up significantly” if mortgage rates increase, Ratiu said.

Another concern could be credit availability. Many lenders opted to impose tougher credit and income requirements for prospective mortgage borrowers to avoid taking on too much risk during the COVID-19 crisis. “This has eased somewhat, but given lenders’ hesitance throughout 2020 —  despite supportive Fed policies —  it’s unclear how much of an impact changes to the Fed’s asset purchases would have on lenders’ strategies,” Wood said.

Counterpoint: How tapering could help

While most economists argue that rolling back the Fed’s asset purchases would lead to higher interest rates, others argue that it could actually have the reverse effect.

Inflation remains a major boogeyman for investors, and if the Fed gets that in check it’ll have positive ripple effects.

“The onset of tapering may help more than hurt mortgage rates because the risk of sustained higher inflation only grows the longer the Fed maintains their current pace of asset purchases,” said Greg McBride, chief financial analyst at Bankrate.com. “With the timetable for the first interest rate hike looking to come in 2022, this may provide some comfort to investors that buy long-term Treasury and mortgage bonds that the Fed will eventually respond to higher inflation.”

Additionally, wage growth could keep pace with rising mortgage rates — or even outpace interest-rate appreciation, Ratiu noted. That could counter some of the challenges posed by rising home prices and make qualifying for a mortgage easier for some households.