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Predicting the path for mortgage rates

Tom Reddin
Tom Reddin, former president of Charlotte-based LendingTree, writes an occasional column for Sunday Business about mortgages and home ownership. A version of this column previously appeared on his blog, MortgageRates.us. He runs Red Dog Ventures, a venture capital and advisory firm for early stage digital companies.

Follow him on Twitter.

Where will mortgage rates go from here?

Back in February I forecasted that mortgage rates would tick up as the year progressed, and the economy slowly improved.

Well, rates have in fact increased. My forecast back then was that rates would gradually rise from the then current 30-year fixed rate of 3.5 percent upward towards 4 percent, and most likely stay within that range for the year.

Since then, we’ve seen rates rise and even exceed that forecast, especially over the past month. Rates have increased to 4.37 percent with 0.7 points paid at closing as of last week, according to the Freddie Mac Primary Mortgage Market Survey. That’s up almost a percentage point from the same time a year ago, when rates were at 3.53 percent.

So where are rates headed from here? The answer lies in two core areas: the economy and the Federal Reserve.

First, let’s take a look at the economy. The U.S. economy is growing, unlike some of its European allies, but at a paltry 2 percent growth rate. In fact, the most recent update from U.S. Bureau of Economic Analysis downgraded the first quarter of 2013 to a 1.8 percent growth rate. While some European countries may look at this with envy, it’s a lackluster recovery from the very deep recession we recently experienced. But nevertheless, the U.S. economy has shown signs of recovery and it is indeed growing.

As economies grow, demand for credit increases and investors start to worry about inflation – both factors which usually lead to higher interest rates. So, as long as the economy continues to recover and growth accelerates, we should expect to see continued increases in interest rates.

The second major driver is Ben Bernanke and the Federal Reserve. The Fed has been purchasing approximately $85 billion of bonds a month, under what has been dubbed Quantitative Easing 3, or QE3.

Some people call this stimulus program “QE Perpetuity” since it’s the first of three stimulus programs with no official end date built into the program. This program – which essentially prints money – drives up demand and therefore the price of bonds, which in turn drives down interest rates.

There is no doubt that this has kept mortgage rates low, and Wall Street is watching the Fed like a hawk to see if there are any signs of the Fed tapering off or winding down this program.

No one knows exactly what the Fed will do, but it’s not unreasonable to assume that they will gradually start to taper off the bond buying program either later this year, or sometime next year – as long as the economy continues to grow, unemployment rates continue to decline, and inflation levels start to increase. Assuming we stay in an economic recovery mode, it really comes down to when, not if the Fed will start to taper back on this program.

That’s the big debate on Wall Street these days. The stock market declined hundreds of points over the past month based on some inferences of what Ben Bernanke said a few weeks ago when he mentioned that the Fed could possibly start winding down this extraordinary stimulus program by the end of this year.

Then Bernanke later said the economy still needs “highly accommodative monetary policy for the foreseeable future” which led investors to believe that maybe the Fed won’t be tapering off the QE3 program anytime soon, which in turn caused the stock market to bounce back up to new record highs.

‘Don’t be the hog’

The bottom line is this: No one can guess exactly what the Fed is going to do, and when the Fed is going to begin to throttle back on this stimulus program.

However, as long as the U.S. economy continues to demonstrate growth, preferably in the 2-3 percent range, the Fed will gain strengthened confidence that the economy is on the right track and will start to taper back on their QE3 bond buying program. When that happens, which in my opinion seems likely over the next year or two, we should see mortgage rates continuing to rise back to more normalized levels.

If you are thinking about buying or refinancing a home, remember, we are still enjoying extremely low mortgage rates. Rates were north of 10 percent during the ’80s, in the 7-9 percent range in the ’90s, and roughly in the 6 percent range for most of the first decade of the 2000s. Yet now, we have an average rate of 4.37 percent.

Have we already seen the bottom of mortgage rates? Quite possibly yes. Could rates dip down again? Yes, if there is a negative shock in the world that jolts the markets and causes investors to run towards safer investments like government bonds and mortgage-backed bonds. But are rates more likely to go up over the next year or two? Yes, in my opinion, as long as the economy continues to steadily grow, and the Fed gains confidence along the way.

There is an old saying on Wall Street: “Bulls win, bears win, and hogs get slaughtered.” My advice: Don’t be the hog – take advantage of these nice low rates while they’re still around.

Visit my blog at MortgageRates.us to learn other tips to manage your home financing.

Tom Reddin, former president of Charlotte-based LendingTree, writes an occasional column for MoneyWise about mortgages and home ownership. A version of this column previously appeared on his blog, MortgageRates.us. He runs Red Dog Ventures, a venture capital and advisory firm for early stage digital companies.
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