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Why are mortgage rates rising before the Fed changes its policy?

Q: I understand that mortgage rates are rising because the Federal Reserve might stop buying mortgage securities later this year -- but why are rates rising already when the Fed hasn't changed its policy yet, and will things get even worse when that policy change actually happens?

A: There are two related reasons why mortgage rates are rising. One is that the economy appears to be improving, and the other is the expectation that the Fed will back away from its stimulative policies, perhaps as early as this year. The two are related because interest rates tend to rise when the economy is stronger, and because a stronger economy would eliminate the need for Fed stimulus.

As you mention, no change has occurred yet, or is even definitively scheduled at this point. So why are mortgage rates already rising? Well, mortgage lenders make loans that regularly stretch over 15 or 30 years. If they anticipate that rates might be headed higher, they are not going to lock themselves into lower rates for such a long period of time. The nature of mortgages, because of their length, requires mortgage lenders to think a long way ahead.

As for whether rates will rise further once the Fed's change in policy actually occurs, you should be advised that in the years immediately before the financial crisis and Great Recession resulted in the Fed's extraordinary intervention in the mortgage rate market, 30-year mortgage rates were typically in the 5 to 7 percent range. Therefore, take away that intervention, and it is reasonable to assume that mortgage rates would make their way back toward that range.

If 5 to 7 percent sounds like a radical change from the 3 to 4 percent of the past couple years, they could rise even higher if inflation picks up. There are many things to look forward to about the economy getting back to normal, but consumers won't welcome a return to more normal mortgage rates.

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