The Main Reason Mortgage Rates Are So High

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 some context to help you answer such questions.

1. Why Are Mortgage Rates So High?
The supply and demand for mortgage-backed securities (MBS) heavily influence the 30-year fixed-rate mortgage. Investopedia reports:

“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 mortgage-backed security is essentially lending money to home buyers.”

MBS demand influences the disparity between the 10-year Treasury yield and the 30-year fixed mortgage rate. The average spread between the two historically is 1.72 (see figure below):

The mortgage rate was 6.85% on Friday morning. That means the spread was 3.2%, over 1.5% more than typical. Mortgage rates would be 5.37% if the spread remained at its historical average (3.65% 10-Year Treasury Yield + 1.72 spread).

This widespread is really unusual. According to George Ratiu, Chief Economist of Keeping Current Matters (KCM),

“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 illustrates this argument using historical data by illustrating the rare times the spread has expanded to 300 basis points or more:

The graph depicts how the spread has decreased after each high. The good news is that there is still room for mortgage rates to rise today.

So, what's generating the wider disparity and driving up mortgage rates 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 of 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 of First American, provides an answer in a recent blog post:

“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.”

In conclusion
When investors' panic subsides, the spread will narrow. As a result, mortgage rates should begin to fall as the year progresses. However, no one can predict exactly what will happen when it comes to mortgage rates.

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