The average rate for a 30-year fixed-rate mortgage has fluctuated between just above 4% and 4.5% for most of 2014. The Federal Home Loan Mortgage Corp., or Freddie Mac as it is commonly called, is predicting rates will rise to 5% in late 2015. (For more, see: How To Shop For Mortgage Rates.)
Mortgage rates are determined by a number of factors tied to the economy, the debt markets and Federal Reserve policy.
Link To Treasury Bonds
Interest rates on fixed-rate mortgages are linked to Treasury bond rates. Treasury bonds are issued by the U.S. Treasury Department to pay for debt.
The rate on 30-year fixed-rate mortgages, for example, is typically tied to the yield on 10-year Treasury bonds. The yield is the rate of return expressed as a percentage. When the yield goes up or down so do interest rates.
Rates on adjustable rate mortgages (ARMs), meanwhile, are tied to the Federal funds rate. This is the rate at which a depository institution or bank lends funds maintained at the Federal Reserve to one another overnight. (For more, see: Mortgages: Fixed-rate vs. Adjustable Rate.)
When the economy is ailing the Federal Reserve keeps interest rates low to encourage borrowing and stimulate spending among consumers. This is what happened after the financial and housing markets collapsed and why rates have remained at historical lows.
Quantitative Easing To End Soon
In an unusual move following the collapse of the markets, the Federal Reserve began a quantitative easing (QE) program in late 2008. In an effort to boost the economy and housing markets it began buying U.S. Treasury bonds and mortgage-backed securities, which helped lower mortgage rates. (For more, see: Quantitative Easing: Does It Work?)
The Fed has bought more than $4 trillion in Treasury bonds and mortgage-backed securities since the inception of the program.
Interest rates are expected to rise after the Federal Reserve's quantitative easing bond-buying program is tapered off. The Fed has indicated it will most likely end in October. (For more, see: What Will Happen To Treasury Yields With Yellen And Tapering?)
Other factors contributing to an anticipated rate increase include a strengthening economy. Economic growth is expected to average 3.3% in 2015, according to Freddie Mac. The unemployment rate is also falling and is expected to continue to do so. Remember, when the economy is struggling interest rates are kept low to stimulate growth. (For more, see: What The Unemployment Rate Doesn't Tell Us.)
Mortgage rates were expected to rise sooner. But the Federal Reserve, headed by Janet Yellen, is balancing — not raising — rates too early to prevent harming a still delicate economy and housing market.
The Bottom Line
Barring another financial and housing market implosion, and if the economy continues to improve, expect interest rates to rise in the latter half of 2015. If they do jump to the 5% range it will be a modest hike when compared to historical averages. Rates will still be far below the approximately 8.5% 30-year fixed-rates mortgages have averaged since 1971 when Freddie Mac started tracking them. Rates averaged 6% in the years leading up to the recession. (For more, see: Mortgage Basics: An Introduction.)