Will interest rates hit 5 percent by the end of 2013?

Mortgage interest rates have been climbing in the past few months. Will that trend continue?

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How high will interest rates go?
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How high will interest rates go?

If you're in the market for a home or thinking of refinancing the one you own, it's safe to say that you have been watching mortgage interest rates closely. So you've seen that over the past few months they've had a disturbing trend: Rates are going up.

For instance, according to the "Weekly Primary Mortgage Market Survey®" conducted by Freddie Mac, the average interest rate for a 30-year, fixed-rate mortgage back on May 2, 2013 was 3.35 percent. As of September 12, 2013, the rate climbed to 4.57 percent - more than a full percentage point. On a $300,000 mortgage, that could mean an extra $210 a month, and over $75,000 in interest over the life of your loan. Ouch!

So if you're on the fence about buying a home or refinancing, one of the most important questions to ask is whether that number will go higher. Could it actually reach 5 percent by 2014?

We did some digging on the subject and looked into reasons rates are climbing - and how fast.

Talks of QE3 Tapering

No, QE3 Tapering is not a new crash diet; it's the plan for ending the Federal Reserve's program that has kept interest rates artificially low.

QE3 stands for the third round of quantitative easing, which is fancy talk for the Federal Reserve's program of buying mortgage-backed securities (MBS) and treasuries from banks. They're doing this to encourage the banks to loan money (provide mortgages, for instance) at lower interest rates, and thus stimulate the economy. Since September of last year, the Fed has bought a whopping $85 billion of MBS and treasuries per month.

But in June of this year, Ben Bernanke, the chairman of the Federal Reserve Board, announced that he'd be reducing the amount of securities and treasuries the Fed buys, with the goal of ending QE3 in 2014. If you recall, this is what initially caused interest rates to spike up by a substantial amount. In late September, when everyone was expecting an announcement from the Fed about the program starting to taper, they instead said that the program would continue as is until the economy was deemed strong enough to cut back on the purchases.

Bernanke didn't specify an amount, or even a timeline for tapering - just that the Fed will continue to evaluate the program. But regardless, just the talk of it made an impact on interest rates.

"We've seen that even the mention of QE3 ending has caused markets to be nervous and interest rates to fluctuate," says Christopher Kimball, an associate with Money Concepts, a wealth management and financial planning firm. He adds that it's only a matter of time before QE3 ends altogether, taking away the Fed's tool for keeping rates artificially low. "I don't think that the QE3 can continue. It has to come to an end sooner or later and everybody knows it," says Kimball.

While he can't make any solid prediction of how high interest rates will go when it does end, Kimball says that there is nowhere for rates to go but up. Considering that as of September 2013 the average interest rate on a 30-year, fixed-rate mortgage stood at 4.57 percent, that doesn't make 5 percent so unlikely.

[Wondering what kind of interest rates you might qualify for? Click to find a lender now.]

The Economy is Showing Signs of Improvement

In addition to the repeal of QE3, a strengthening economy is another reason that mortgage interest rates might rise. And, that's one reason Bernanke also gave for the Fed's plan to taper and then end QE3.

"Generally, in improving economies, interest rates rise," says Jim Duffy, a mortgage banker with Cole Taylor Mortgage.

And some leaders in the housing industry believe the economy is on its way back.

"I am very optimistic about the U.S. economy, and I can tell you that we're definitely seeing a real recovery in housing," says Emile Haddad, president and CEO of FivePoint Communities, one of California's largest real estate and management companies.

One indicator of a strong housing recovery, for example, is the National Association of Home Builders(NAHB)/Wells Fargo Housing Market Index. It revealed that builder confidence in the market for newly built, single-family homes had a reading of 58 in September 2013. This is highest level it has been at in almost eight years, according to the NAHB website.

What's more, while the Commerce Department reported that the economy grew at a pace of just 1.1 percent for the first three months of 2013, that pace increased to a 1.7 percent rate for the second quarter (April through June).

Inflation May Hit

A little bit of inflation is a good thing; it is a possible sign of a healthy economy, says Duffy. Unfortunately, for those who want to buy a home or refinance, inflation can drive up interest rates, he says.

If you're in that group, you might be interested to learn that the U.S. Department of Labor's latest Consumer Price Index, issued August 15 and considered an inflation indicator, reported: "Over the last 12 months, all the items indexed increased 2.0 percent before seasonal adjustment."

And some economists are projecting that inflation will rise even more in 2014 and 2015.

In June 2013, a survey conducted by Bloomberg revealed that inflation is expected to hit in 2014 at 1.5 to 1.8 percent, then increase by 1.7 to 2 percent in 2015. A separate report by the global investment and research firm CME Group titled "U.S. Inflation: Delayed, Not Denied," gave a 75 percent probability that inflation would exceed 2 percent in 2014, and 3 percent in 2015.

And while Duffy doesn't believe that inflation is a big factor at the moment, when coupled with other factors that put upward pressure on mortgage interest rates, it could be a factor soon.

But, he does say that those who are worrying about double-digit interest rates can stop worrying. He doesn't see that happening.

"But in the short-term I could easily see rates go to 5.5 or 6 percent," he says. And, he adds, since every percentage point rise in interest rate effectively means a 10 percent drop in your buying or refinancing power, a percent or two is nothing to scoff at.

Doing the Math

All this talk might make your head spin. And sometimes, some simple number crunching can bring it all into focus. So, let's look at the costs of a typical $300,000, 30-year, fixed-rate mortgage at three different interest rates: 4.5 percent, 5 percent, and 5.5 percent. That might give you a better feel for what may lay ahead if you do wait to refinance or purchase a home, if indeed rates rise.

Mortgage Interest Rate Monthly Payment Total Interest Over Life of Loan
4.5 percent $1,520 $247,220
5 percent $1,610 $279,767
5.5 percent $1,703 $313,212

The bottom line? Waiting even just a few months could pinch your wallet more than you might think.

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