Why the Mortgage Rates Dropped After the Fed Rate Hike

At the end of the year in December, the Federal Reserve actually increased rates for the first time in almost a decade. Surprisingly, mortgage rates actually dropped when this happened. How’d this happen and will the trend likely hold up for home buyers in 2016?

Immediate mortgage rete reaction to Fed meeting

Majority of U.S. mortgage loans up to $417,000 are pooled into bonds called Mortgage Backed Securities (MBS), and they are traded around the global market. During the course of a trading day, mortgage rates will fall as the price of these MBS’s rise, and vice versa.

On December 16, the mortgage rates rose when investors sold MBS ahead of the meeting that day. While expecting the Feds would raise rates at the end of the year, and not knowing how the Fed might position 2016 rate policy entirely, MBS investors played the conservative card, and sold before the meeting.

Once it was announced that rates were raised, the Fed claimed they would only raise it .25%, and will take a “gradual” approach to tightening the policy from there.

Bond markets didn’t go into a tizzy, but reacted favorably, and MBS buying resumed, pushing mortgage rates down.

Mortgage rate outlook based on revised Fed policy

Markets are predicting this “gradual” approach means raising interest rates four times throughout the year to total the hike at 1%.

The fed Funds Rate is supposed to influence broad rate markets overall, not to directly impact mortgage rates. For example: the last time the Fed lifted fed Funds was from June 2004 to July 2006, hiking a total of 4.25%. While all this was happening a 30-year fixed rate mortgage only rise 0.5%.

If 2016 estimates call for Fed Funds to rise, mortgage rates probably won’t rise by that full amount. However, there happens to be another element of Fed policy that does directly impact mortgage rates.

The Fed began buying MBS in January of 2009 to push MBS prices and keep mortgage rates down. Lately the Fed has slowed down on buying these, but still buy enough to influence mortgage rates.

The Fed has said they will still be buying MBS as they move throughout the Fed Funds rate hiking cycle. Hopefully they haven’t lied, and this will prevent a sharp spike in mortgage rates.

What higher mortgage rates mean for home buyers

Combining all these factors, market estimates call for mortgage rates to rise another 0.5% by mid-2016.

Most home shoppers wouldn’t be drive out of the market by this hike, but likely scale-down what they would be shopping for. Monthly mortgage payments would likely have a little increase for sure.

Overall this shouldn’t kick you out of the shopping market, but just force you to buy something a little less. 

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