Historically low mortgage rates that borrowers have enjoyed this year will soon begin moving in the only direction left to go -- up -- but it will be a shallow climb.
Economists predict mortgage rates for 30-year fixed loans, which average about 5 percent now, could begin notching up closer to 6 percent by early next year and then slowly continue rising through 2010 and beyond. The same pattern of gradually increasing rates will be true for other types of mortgages, such as adjustable-rate and 15-year fixed, but they are less likely to appeal to borrowers when 30-year fixed-rate loans remain affordable.
Higher rates are coming because government programs put in place to support mortgage lending during the financial crisis will expire next March. Those programs, which have been extended once already, allowed the Federal Reserve to act as buyer of last resort for mortgage-backed securities when investors shied away from those products. "The Fed is betting that private investors will be ready to step into the fray next spring," said Keith Gumbinger, a mortgage analyst at financial publisher HSH Associates. As a result, "interest rates will need to rise if only to attract capital," said Amy Crews Cuttes, a deputy chief economist at Freddie Mac, who expects rates to remain about 6 percent next year.
No huge spikes are expected in the immediate future in part because the sluggish economy inhibits inflation, one of the key drivers of higher mortgage rates, and because a watchful Fed doesn't want skyrocketing rates to derail the still fragile recovery.
"If we did see a sharp increase in mortgage rates, the Fed might rethink their exit strategy," said Robert Dye, a senior economist with PNC Bank. If so, the government's mortgage-buying programs could be extended again to help keep rates stable.
How high rates will rise after next year is anybody's guess. A strengthening economy brings with it the potential for inflation. Other trends, like a weakening dollar, also bear watching because they contribute to inflation, which in turn drives up mortgage rates.
"It wouldn't be hard to see rates at 7 percent or 7.5 percent by the middle of 2011," Dye said. "But there are a lot of ifs out there," including how the markets will react to the withdrawal of government supports. And while no one anticipates a return to the steep double-digit rates of the 1970s and '80s, Gumbinger isn't willing to discount the potential for them to be in the high single digits a few years from now.
"We did have rates as high as 9 percent at the beginning of this decade," he said. Though that's unlikely in the next few years, "it's not out of the realm of possibility."