The Primary Cause of High Mortgage Rates

Mortgage rates are currently on the minds of many homebuyers. As a result, if you're considering buying for the first time or selling your present home to move into a property that better meets your needs, you may be asking yourself two questions: 

1. Why Are Mortgage Rates So High?

2. When Will Rates Go Back Down?

Here’s context you need to help answer those questions.

1. Why Are Mortgage Rates So High? 

The 30-year fixed-rate mortgage is largely influenced by the supply and demand for mortgage-backed securities (MBS). According to Investopedia: 

“Mortgage-backed securities (MBS) are investment products similar to bonds. Each MBS consists of a bundle of home loans and other real estate debt bought from the banks that issued them . . . The investor who buys a mortgage-backed security is essentially lending money to home buyers.”

Demand for MBS helps determine the spread between the 10-Year Treasury Yield and the 30-year fixed mortgage rate. Historically, the average spread between the two is 1.72 (see chart below):

Last Friday morning, the mortgage rate was 6.85%. That means the spread was 3.2%, which is almost 1.5% over the norm. If the spread was at its historical average, mortgage rates would be 5.37% (3.65% 10-Year Treasury Yield + 1.72 spread).

This large spread is very unusual. As George Ratiu, Chief Economist at Keeping Current Matters (KCM), explains:

“The only times the spread approached or exceeded 300 basis points were during periods of high inflation or economic volatility, like those seen in the early 1980s or the Great Financial Crisis of 2008-09."

The graph below uses historical data to help illustrate this point by showing the few times the spread has increased to 300 basis points or more:

The graph shows how the spread has come down after each peak. The good news is that that means there’s room for mortgage rates to improve today.

So, what’s causing the larger spread and making mortgage rates so high today?

The risks connected with investing in MBS have a significant impact on demand for them. Today, that risk is influenced by broader market conditions such as inflation and concern about a potential recession, interest rate hikes by the Fed to try to reduce inflation, news that creates needlessly negative narratives about home prices, and more.

Simply said, when there is less risk, demand for MBS increases, and mortgage rates fall. On the other side, if MBS is more risky, demand for MBS will be limited, and mortgage rates would rise as a result. Mortgage rates are now high due to a lack of demand for MBS.

2. When Will Rates Go Back Down?

Odeta Kushi, Deputy Chief Economist at First American, answers that question in a recent blog:

“It’s reasonable to assume that the spread and, therefore, mortgage rates will retreat in the second half of the year if the Fed takes its foot off the monetary tightening pedal and provides investors with more certainty. However, it’s unlikely that the spread will return to its historical average of 170 basis points, as some risks are here to stay.”

Bottom Line

The spread will narrow as investors' concern subsides. As a result, mortgage rates should start to fall as the year progresses. However, no one can predict mortgage rates with certainty.