Mortgage Rates (finally) Head Lower

We are amidst the long-awaited shift in mortgage rates. It appears they are finally headed back toward normalcy. After peaking at 8%, mortgage rates have recently fallen to 6.3%. This drop will be welcome to anyone who is considering purchasing a home, but I think there is still substantial room to fall further. In this post, we'll explore the factors influencing these rates and the outlook for the future.

The Relationship Between Mortgage Rates and the 10-Year Treasury

Mortgage rates are based on the 10-year U.S. Treasury yield. While rates have come down slightly since their peaks, the 10-year Treasury is still 1-2 points above its historic average. This elevated level suggests that there is room for mortgage rates to decrease as the Treasury yield returns to its normal range.

To be specific, mortgage rates are based on a spread above the 10-year Treasury rate. This spread is influenced by risk tolerance at the banks. When banks are more risk tolerant, the spread is lower. When they are less risk tolerant, the spread is higher.

From 2015 to 2019, the spread between the 10-year Treasury and the 30-year mortgage rate averaged around 1.7 percentage points. However, this spread currently stands at 2.5 points, indicating a higher margin than usual. As we move out of a period of uncertainty and towards “normalcy,” we can expect this spread to fall back to historic averages. That means we can expect an additional point of lower mortgage rates simply from a lower spread.

The Path to Normalization

Based on historical data and market conditions, we anticipate that mortgage rates could fall by an additional 1.5 to 2.5 points from their current levels once we achieve a full "return to normal." This normalization process, however, hinges on broader economic trends and developments.

If the economy continues to grow without slipping into a recession, it might take 1.5 years or more before we see mortgage rates stabilize at the lower end of the expected range. Conversely, if a recession occurs or appears imminent, rates might drop more swiftly as the Federal Reserve and other policymakers take action to stimulate the economy.

Preparing for Future Changes

If you’ve been waiting on the sidelines to buy a home, your time might come soon. Be sure to invest your down payment in a safe asset allocation to ensure you are protected in the event markets take a downturn. At the same time, you may not want to hold all cash, as home prices could continue to rise and cash fails to grow at a similar pace.

In conclusion, while the recent decline in mortgage rates is a welcome development, there is potential for further decreases. By keeping a close eye on economic trends and market indicators, you can make informed decisions that align with your financial goals.

If you’re considering buying a house, contact us at Toups Capital Advisors. We have tools to help you budget for a purchase and recommended portfolios based on your home purchase timeline.