The federal funds rate doesn’t directly dictate mortgage rates, but it does steer market activity to create higher rates and reduce demand. So far, the short-term fed funds rate that the Fed directly controls has risen by 175 basis points but the 30-year fixed rate mortgage has risen by nearly 300 basis points, said Lawrence Yun, chief economist at the National Association of Realtors (NAR).

“It’s painful that on the same $300,000 mortgage, the monthly payment rose to $1,800 today from $1,265 in December. Consequently (it) will shrink the buyer pool,” Yun said, adding: “Sales could fall even further with some inventory sitting on the market for more than a month like in the pre-pandemic days.”

The consumer-price index rose 8.6% in May from the same month a year ago, marking the highest reading since December 1981, according to the U.S. Labor Department. With investors asking for higher premiums to invest in assets caused by the expectation of higher U.S. Treasury rates, the 30-year conforming mortgage rate passed the 6% mark on Tuesday, per Black Knight‘s Optimal Blue OBMMI pricing engine. In early January, rates were as low as 3.4%.

Another factor putting upward pressure on mortgage rates is the “ongoing reduction in the size of the Fed’s balance sheet, including its holdings of the mortgage backed securities (MBS),” said Mike Fratantoni, chief economist at the Mortgage Bankers Association.

The purchase of Treasuries and MBS, which ended in March, helped the housing and mortgage markets to expand to new heights. The sharp decline in mortgage rates during the COVID-19 pandemic fueled the U.S. mortgage industry to fund $4.1 trillion in new loans in 2020 and $3.9 trillion in 2021, according to the MBA. In its June report, the MBA forecast total originations at $2.4 trillion in 2022 and $2.3 trillion in 2023.

A less volatile market?

Although the 30-year fixed-rate mortgage surpassed 6%, its highest level since November 2008, some economists expect mortgage rates to go down in the coming weeks. As mortgage rates tend to fluctuate in anticipation of the Fed’s rate moves, “the Fed increase was already ‘baked into’ mortgage rates,” said Holden Lewis, home and mortgage specialist at NerdWallet.

“In other words, mortgage rates are more likely to go up or down before Fed meetings than after Fed meetings. Over the next week or two, we probably won’t see big movements in mortgage rates like we did last week,” Lewis said.

If the Fed can manage concerns that it is moving too fast or too slow while bolstering credibility that they do intend to bring inflation back into the target 2% range within a reasonable period, the recent volatility seen in the stock and financial markets could subside, said Danielle Hale, chief economist at Realtor.com.

Though there is possibility that the Fed comes across as acting without concern for the broader economic impact leading to a new round of vulnerability, “I expect a bit more calm following the June meeting as the Fed seeks to lay out a clear path forward, but there’s both upside and downside risk for mortgage rates,” Hale added. The Fed will meet again in July.

Avoiding volatility in mortgage rates are what some lenders prefer to see more than the Fed’s aggressive monetary policy to better predict the housing market.

How lenders can navigate a shifting market with non-QM loan options

In an effort to counter margin compression and satisfy a new generation of homebuyers, lenders are looking to offer loan options that better fit the average borrower. HousingWire recently spoke with John Keratsis, President and CEO of Deephaven Mortgage, about the potential benefits of non-QM lending in today’s tight housing market.  

Presented by: Deephaven 

“Based on our conversations with clients, we believe many market participants will be pleased with the aggressive approach of the Federal Reserve, as there is some belief the Fed’s decision will more quickly bring stability to the home mortgage interest rate environment,” said Marty Green, principal at mortgage law firm Polunsky Beitel Green.

The biggest issue regarding volatility in the mortgage rate environment is the uncertainty around the size of the Fed’s upcoming rate hikes. Federal Reserve chairman Jerome Powell said either a 50 bps or 75 bps increase seems likely at the July meeting, but emphasized the central bank’s decision will depend on incoming data.

“Any guidance that we give is always going to be subject to things working out about as we expect,” Powell said in a press conference following the rate increase announcement. “I would like to think though that our guidance is still credible, but it’s always going to be conditional on what happens.”

If the Fed’s monetary policies fail to slow down inflation, mortgage rates towards 7% or higher could be on the horizon, as seen from the inflationary environment of the 1980s, said Robert Heck, vice president of mortgage at online mortgage broker Morty.

“We aren’t close to being there yet, but it’s also not impossible and inflation data will be the market driver of the summer and the remainder of the year.”

A cool down in an overheated housing market 

What remains clear for industry observers is that higher mortgage rates will cool down the housing market. “This means that affordability will deteriorate further and dampen some of the demand,” said Selma Hepp, deputy chief economist for CoreLogic, adding the higher rate will bring more inventory into the housing market.

Existing home sales dropped 2.4% in April from March to 5.61 million, according to Realtor.com. A total of 591,000 new homes were sold in April, falling 16.6% from March, which was the lowest level in two years.

Christian Dicker, senior loan officer at Motto Mortgage, said he expects fewer people to qualify for a mortgage in the rising rate environment. After revisiting one of his client’s pre-approvals from last year, he had to call to scale down the $300,000 mortgage to about $260,000.

“It’s about the payment. If the interest rates go up, and the payment gets too high, then they don’t qualify anymore.”

Fewer buyers in the industry means margin compression for lenders, which are relying heavily on purchase mortgages coming off a refi boom. Purchase locks, which are not as rate-sensitive as refinancings, accounted for 82% of the entire share of rate locks in May, according to Black Knight. As a result, brokerages and mortgage lenders have been cutting staff to cut costs in a greatly reduced volume compared to the pandemic.

There’s still demand for homes, loan officers told HousingWire. “I think that homes are still going to sell,” said Coley Carden, vice president of residential lending at Winchester Co-Operative Bank. “It’s a question of what loan product you are willing to go into to make your purchase affordable.”