Why Interest Rates are Likely to Rise in 2010
Mortgage interest rates have hovered around 5 percent during the past year and have even reached record lows in the last few weeks, yet it seems the winds could be changing soon for the rate market. A recent article from Bloomberg quoted the following prediction from a Morgan Stanley economist:
"Yields on benchmark 10-year notes will climb about 40 percent to 5.5 percent, the biggest annual increase since 1999," according to David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. "The surge will push interest rates on 30-year fixed mortgages to 7.5 to 8 percent, almost the highest in a decade," Greenlaw said.
Is it really possible for mortgage rates that have been so comfortably low for years to rise up 2.5 to 3 percent in the near future? How could that happen? It is actually a forecast that is being espoused by many economists these days. The reason for the rate hike appears to be a combination of the end of the Fed securities buy-back program and potential difficulty in selling off U.S. debt.
The Federal Reserve had been actively buying up soured mortgage-backed securities (MBS) from off the market for the past year as a way of saving private investors from losing more money. But the Fed has vowed to stop MBS purchases as of March 31, 2010. One potential outcome of this government pull-out is that there will be few private investors willing to put their money back into mortgage-backed securities. These investments have been very risky since the popping of the housing bubble and without the promise of the Fed to buy up all the toxic securities, there will be little incentive to sink money into investments backed by loans that still have a high likelihood of foreclosure. For private investors to start investing in MBS again, the yields are going to have to be much higher, and some say that will cause a dramatic rise in rates this year. Also, some analysts are saying that if rates should rise to as much as 6 percent soon, home prices could fall by about 10 percent this coming year – not exactly the type of housing recovery most are hoping for!
The other issue is government debt. Mortgage interest rates typically follow bond rates, and during 2009 there has generally been a strong demand for U.S. bonds from foreign central banks. This has kept rates very low, but demand could drop off in 2010 if the strength of the dollar continues to falter and the U.S. continues to borrow at its current speed. If foreign banks stop buying up U.S. debt, mortgage rates will rise.
Higher rates mean hard times ahead for the housing market. Home sales could drop, which could lead to a drop in home values. As ARM loans reset, higher rates could cripple homeowners and contribute to another wave of foreclosures across the country. While there may be nothing that can stop this process, the best advice for individual homebuyers at this point is to quickly lock in today’s current rates before things start moving upward.