Part I

What a roller coaster ride it’s been for mortgage interest rates!  Potential homebuyers seem to have adjusted to the idea of mortgage interest rates in the 6s for now, but it’s easy to get nostalgic over the 3% rates that we enjoyed for close to two years.  A deeper look, however, reveals that low rates added fuel to the fire that was burning in the housing market.  As we look back, this period may come to be remembered as The Time the Government Broke the Housing Market.

Intro:  Just a quick reminder:  These articles I share here are researched and written by me!  As part of my commitment to ongoing support for my clients and partners, I write these articles to help them understand what’s really happening in the markets, beyond the headlines and soundbites.

In early 2020, as COVID-19 descended upon the US, many businesses chose to reduce operations or shut down completely.  Others were forced to.  Predictably, this created a sharp downturn in the economy.   The Federal Reserve (FED) stepped in with a broad variety of actions to ensure that credit continued to flow and we didn’t have a complete collapse of the credit markets like we did in 2008.  In our case, we’re interested in the FEDs commitment to buy US Treasury Bonds (UST) & Mortgage Backed Securities (MBS).

Since the 1970s, US Treasury Bonds (specifically the 10 year) and Mortgage Backed Securities have moved inversely to one another.  This predictability of this relationship is critical to the flow of credit in the economy.  In early 2020, this relationship went sideways, and the FED moved to restore the smooth functioning of these markets by purchasing large quantities of both UST and MBS.  Ultimately, The FED committed to unlimited purchases of both, stating that they would purchase these “in the amounts needed to support smooth market functioning and effective transmission of the monetary policy to broader financial conditions.”  And with this, the stage was set to bring about the lowest mortgage rates in US history.

Before we get into the immediate effect, it’s important to understand the reason behind the effect.  Mortgage Backed Securities are bought & sold like stocks and bonds.  Their value directly affects interest rates of fixed-rate mortgages.  The higher the value of MBS, the lower the corresponding mortgage interest rate.  As MBS demand soared thanks to the FED (who publicly committed to purchasing unlimited quantities), so too did their value.  And as the value of MBS soared, mortgage interest rates plummeted to lows never seen before in the US.

For a homeowner, the rate of interest they pay on their mortgage is very important, as it drives the amount of their monthly payment.  As mortgage rates plunged in early 2020, one result was an increase in the affordability of homes.  This gave an important boost to the housing market, which had already been struggling with lack of inventory.  Even before COVID-19, there were just not enough homes for sale on the market relative to the number of prospective buyers.  And as we continue to see, the combination of low supply & high demand pushes home prices up.  Incredibly low interest rates only compounded this challenge.

Even before the low-rate frenzy that started in Spring of 2020, buyers were already bidding against multiple other buyers on most homes for sale.  Suddenly, with mortgage interest rates so low and home affordability so high, a flood of buyers entered the market, intensifying already-stiff competition in a market struggling with inventory.  As competition for homes increased, so too did concessions that buyers would offer sellers for the privilege to buy their home – they would waive a home inspection, offer free occupancy to the seller after the closing, pay the seller’s closing costs, and of course, offer a sales price above the home’s listing price.  After all, when the monthly cost to borrow an additional $50,000 is about $200, many buyers simply saw that as the Price of Winning.  The result was a housing market in our area in which people would routinely offer 10 to 15% more than home’s asking price.  The FEDs policy added gasoline to a housing market already on fire.

In our next installment, we’ll continue the story of low rates and their effect on the housing market.

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