Fed policy changes will push mortgage rates higher, sooner

Higher mortgage rates likely on the way

Fallout from the Federal Reserve meeting on Wednesday, Dec. 15 points to the new year coming with interest rate growth.

Based on the central bank’s conclusion that inflation is no longer “transitory,” mortgage rates will likely begin an uptrend in order to combat it.

If you’ve put off refinancing your home loan, the window to take advantage of today’s low rate environment could close quickly.

In this article (Skip to...)

• The Fed’s impact
• The latest meeting
• When will tapering start?
• Should you refinance now?
• Your next steps

How the Fed impacts mortgage rates

The Federal Reserve does not actually determine mortgage rates. Rather, rates are intrinsically tied to the Fed’s actions.

In March 2020, the Fed started buying mortgage-backed securities (MBS) – a type of bond that greatly influences interest rate movement. The more money the Fed puts into MBS purchasing, the lower rates go.

As the central bank pumped about $40 billion per month into MBS buying to compile nearly $2.6 trillion of the asset class, mortgage rates fell and stayed near historic lows for the past 20 months.

The central banking system started its purchase program to help offset the negative impact COVID–19 had on the economy.

However, the Fed previously announced it will reduce its MBS purchase program, eventually getting it to zero. This “tapering” will likely drive mortgage rates past the mid-3% range in 2022.

What happened in this week’s Fed meeting

The Federal Open Market Committee (FOMC) is the decision-making group for the Federal Reserve. It met on Dec. 14 and 15 to discuss the country’s economic projections and appropriate monetary policies going forward.

Following the meeting, the FOMC said positive economic indicators around vaccination rates, policy and employment figures confirmed its decision to taper MBS buying:

“In light of inflation developments and the further improvement in the labor market, the Committee decided to reduce the monthly pace of its net asset purchases by $20 billion for Treasury securities and $10 billion for agency mortgage-backed securities.”

When will the tapering start?

An improved economic forecast led to the Fed taking a more aggressive approach in decreasing its MBS purchasing.

The central bank will begin its tapering in mid-January and end the purchase program on the early side of 2022 (instead of in the middle of the year as originally planned).

“Inflation is running well above target, and the job market is booming,” said Mortgage Bankers Association SVP and Chief Economist Mike Fratantoni.

“That is why it was no surprise that the Federal Reserve moved to accelerate their taper of Treasury and MBS purchases, and signaled that the first rate hike will be coming sooner rather than later.”

Tapering could lead to rates above 4%

Industry experts and economists forecasted the average 30-year fixed rate mortgage (FRM) to settle somewhere between 3.4% and 4.1% in 2022. But that was before the latest FOMC meeting.

Using history as a guide, interest rates could skew toward the higher side of those projections – or possibly go above them. Back in 2013, the Fed underwent a similar tapering program.

Below is the monthly average 30-year FRM before and after the tapering announcement on May 22, 2013, according to Freddie Mac data:

• April 2013 – 3.25%
• May 2013 (tapering announcement) – 3.54%
• June – 4.07%
• July – 4.37%
• Aug. – 4.46%
• Sept. – 4.49%

Rates generally moved sideways through the rest of 2013 and ended at 4.46%. Following the FOMC meeting on Dec. 15, 2021, the 30-year FRM inched up to 3.12% from 3.1% the week before.

If interest rates follow the same growth pattern as 2013, they’d increase to levels approaching 4%.

Of course, 2013 didn’t have a pandemic to navigate. How the U.S. continues to recover and whether positive virus cases grow will determine Fed actions in the coming year.

After the Fed’s latest decision, the MBA projected mortgage rates to rise to 4% by the end of 2022 and “may be more volatile as the Fed backs away from the market.”

The time to refi could be ASAP

If interest rates increase alongside the Fed’s MBS tapering as expected, homeowners looking to refinance should act immediately.

All the talk of “historically low mortgage rates” could soon be a thing of the past and borrowers would be wise to take advantage of them while they’re around.

Although, It is important to note that forecasts are educated estimates and don’t always hold true. If the pandemic takes a turn for the worse, interest rates could hold or even fall like we’ve seen in the past.

The FOMC’s latest decision in accelerating the scale-back was appropriate based on current market conditions.

“But it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook,” explained mortgage commentator Rob Chrisman in his December 16 commentary.

Your next steps

Given what we currently know, mortgage rates will be increasing to combat growing inflation so the time to lock in a low rate appears to be now.

For prospective home buyers, rising interest rates means decreasing affordability so house shopping in cooling markets could prove beneficial.

For refinancers, now is the ideal time to find and lock your lowest rate. At the moment, it seems like interest rates have nowhere to go but up.