Key Takeaways
The Fed doesn’t set mortgage rates. Look to the 10-year Treasury for guidance.
If life circumstances dictate a move, do the best with the cards you’re dealt. Avoid making decisions based purely on mortgage rates.
You owe it to yourself and your family to live comfortably, but affordably.
With the Fed slowing the pace of its aggressive rate hiking cycle over the past 15 months, more and more clients are asking me when mortgage rates will come down. It’s not just younger clients looking to buy their first home or a larger home. It’s also empty nesters considering a downsize, mid-career professionals seeking vacation homes, and parents/grandparents wanting to help someone close to them with a down payment on their first house.
Nobody knows for sure when mortgage rates will decrease because there are so many factors involved. Just know the Fed doesn’t determine mortgage rates directly. The 10-year Treasury bond is a better indicator of where mortgage rates are headed. Mortgage rates generally track the rate of the 10-year Treasury yield because both instruments are long-term and because mortgages have relatively stable risk. To compensate investors for the higher risk of mortgages vs. long-term government bonds, rates for fixed mortgages have historically been about one to two percentage points higher than Treasury yields.
However, there are many factors that contribute to interest rates for a mortgage. We are primarily discussing a 30-year mortgage, but each of the following factors would contribute to shorter-term mortgages as well. Home buyers need people to purchase their loans, so demand for mortgages matter. The greater the demand, likely the higher rate you will pay. Other factors that contribute, job growth, the US economy (Gross Domestic Product - GDP), and consumer and public debt levels. Any change in these factors can impact mortgage rates.
You are not alone: My wife and I have two young boys. We were looking to move when rates were close to 3%, but we couldn’t find a suitable home in our price range. Home prices are still very high today, but now a mortgage would cost us a lot more because we'd be giving up our 3% loan and getting into a 7% loan.
But as I remind many of our clients, especially the younger ones, the 7% rates we’re seeing today are not that high by historical standards. We've just been so accustomed to this really low interest rate environment for so long and a lot of people got used to having all this extra purchasing power because their mortgage rates were so low.
Mortgage rates were in the 8% range during much of the 1990s, slightly above the long-term average mortgage rate of just under 8%, since Freddie Mac started keeping records in 1971. And during the high inflation of the early 1980s, the average mortgage rate was at a whopping 16.63%.
On the flip side, the historically low rates are reflected in today’s sky-high home prices. People aren’t looking at the rates themselves—they’re looking at the total carrying costs they can afford. They’re thinking, sure I'll pay $1.2 million for this 2,000 square foot home because my mortgage is only going to be $3,000 a month. Example: I work with a young couple who has been waiting patiently for home prices to come down since the pandemic started. Clearly, that hasn’t happened. Now as interest rates have spiked, I’m telling them: “We can find a mortgage amount that's comfortable for you. And if rates drop in a year or two, you can always refinance.”
Refinancing within the first five years of a mortgage is not typically a significant issue. You’re only adding another few years to your 30-year loan. But if rates drop sharply, say by a full percentage point, and you refinance, you can recoup the cost of refinancing within a year and then everything after that is savings.
Tipping Point
In the meantime, housing inventory is still low. This does not bode well for a drop in home prices anytime soon, especially in desirable areas. Rates could remain in this 6% to 7% range for quite a while. They might even edge up a little. At some point, people needing to move will be forced to adjust and pack their bags, because their family is expanding, or a job change requires relocation, or they’re retiring and need to downsize, or they just need to be closer to extended family to help with childcare or eldercare.
Further, mortgage interest on your primary home is generally tax-deductible – if you don’t use the standard deduction. So, when you consider that you’re mostly paying mortgage interest, not principal, in the early years of a mortgage, the silver lining is you can receive a tax deduction on the higher interest. If you need to move now, incorporate tax savings into your decision rather than playing interest-rate roulette.
Downsizing Decision:
Back when mortgage rates were 3%, we encouraged couples who were downsizing not to pay all cash for their newer smaller home. Even though they had the money to make an all-cash offer, they could finance the new home with a rock-bottom 3% mortgage and invest their remaining cash at a return that would be assumingly higher than a moderately invested portfolio. Debt can be beneficial when the rates are below 5% or so, especially when they were 3%, allowing you to keep your money invested longer seeking potentially greater returns in your portfolio. However, with current mortgage rates hovering around 7%, we advise downsizing couples to use as much cash as possible to buy their new home, aiming for little or no mortgage. The same goes for second homes.
Conclusion Make the move when it’s the right time for your family circumstances, not when you think mortgage rates are better. Yes, it’s complicated. Don’t face it alone. If you or a family member is considering a move or a refinancing, please reach out at any time. We’re happy to assist.
DAN SATZ MS, CFP® is a Wealth Manager at Novi Wealth