COVID-19, or the disease caused by the novel coronavirus, has already made a severe impact on the world economy. Many people are out of work due to the closing of non-essential businesses, and people are beginning to have difficulties in keeping up with their financial obligations.
The economic constraints caused by COVID-19 could result in the loss of 5 million American jobs. The United States economy could also lose $1.5 trillion over the next year. The stock markets have plunged since early March, when the imminent economic impacts of COVID-19 became clear. A recession is almost certain to happen under these extreme circumstances.
In an effort to ease constraints on banks and home buyers, the Federal Reserve Bank cut interest rates to 0 to 0.25 percent on March 15, 2020. This rate cut came only two weeks after another emergency rate cut, underscoring the gravity of the situation.
David Stanger, a real estate professional with Westmarq Real Estate Group, explains how the Federal Reserve Bank’s actions are poised to help new home buyers, existing mortgage holders, and those who want to refinance their properties.
The Effect of Lower Interest Rates
Lower interest rates encourage more money to flow into the economy. This induces businesses to invest more money and tells consumers that it is the right time to buy goods and borrow money.
The Federal funds rate does not affect previously held mortgages, contrary to popular belief. It does affect new mortgages and adjustable-rate mortgages, while providing advantages for those who are ready to refinance their existing mortgages.
Taking Advantage of the Rate Cut
When shopping for a new mortgage, it is important to keep the rate cut in mind. Borrowers may be able to afford a bigger home or take a shorter mortgage term due to the rate cut. A lowered interest rate can save borrowers thousands of dollars per year on their mortgages.
For example, if a homebuyer is able to get a 30-year fixed-rate refinanced mortgage, the rate would be 4.1 percent. Though it may seem counterintuitive, mortgage rates paid by homebuyers do not fall to zero when the Fed cuts rates. The home lender also needs to make money on the deal.
Factors Affecting the Average Mortgage Rate
The average mortgage and refinance rates change each week based on a variety of market and economic indicators. Some factors that affect these rates include economic conditions, government policy, and the financial health of the mortgage borrower.
Inflation is a key factor in how mortgage rates are set. The mortgage lender needs to maintain their rates at a level that is sufficient to compensate for the decrease in purchasing power due to inflation. This ensures that the lender will continue to make a net profit on the mortgage.
Economic growth is another important factor in determining a lender’s rate. Growth indicators including the GDP (gross domestic product) and the unemployment rate influence the rates. Consumer spending and the number of buyers seeking a mortgage are also components of this decision.
If there are too many new mortgages being processed, rates will go higher because there is only so much money that lenders have to distribute.
A declining economy, such as that caused by COVID-19, is responsible for further changes in the average mortgage interest rate. When wages and employment are declining, there are fewer borrowers looking to originate loans. This puts a downward pressure on the average mortgage interest rate.
In today’s atmosphere of social distancing, many real estate agents are prevented from showing properties, and in some states, these businesses cannot open at all, lowering demand even further.
The federal government’s actions, such as those taken by the Federal Reserve Bank, also have a measurable impact on the average mortgage rate. These rate cuts are meant to put more money back into the economy. They do not directly impact the rates posted by lenders, but the increased supply of money put into the economy allows more mortgages to be originated.
The state of the bond market is another factor with a major impact on interest rates. Banks market their mortgage-backed securities (MBS) like investment products. Buyers are attracted by higher yields from these bonds. Government and corporate bonds compete for investors’ favor.
Mortgage lenders often tie their rates to the yield of the 10-Year Treasury bond. Generally, the average rate for mortgage-backed securities is 1.7 percent above the Treasury bond yield. Sellers of MBS securities must offer a higher yield because their repayment does not have a 100 percent guarantee like a government bond.
COVID-19 and Home Buyers
If home buyers are able to purchase a property under these challenging economic conditions, they may find that they are able to receive a highly competitive rate. The Federal Reserve Bank lowered rates in an effort to put more money back into the American economy. Time will tell whether these measures actually help American businesses or whether they are too little and too late.
David Stanger encourages all new mortgage holders and those who are refinancing to keep a close eye on the economy as a whole as well as the Fed’s rates.