A big reason why mortgage rates have been able to remain so low is that inflation has been practically non-existent in recent years. In fact, for the year ending September 30, 2015, there was no percentage change in the Consumer Price Index (CPI). This was primarily due to the decline in energy prices – if it weren’t for those declines, inflation would have been 1.9 percent over that same 12 months. During that period, oil prices fell almost exactly in half – something that is not likely to happen again over the next 12 months. After all, that would entail the price of a barrel of oil dropping to around $22.50. If you have a hard time imagining $22.50 oil (it was over $100 a barrel as recently as July of last year), you had better get prepared for a return of more normal inflation next year. In fact, having seen oil fall so far so fast, it would not be surprising to see a sudden spike in oil prices. That would really push up inflation, and likely mortgage rates as well.
Another possible source of higher inflation is wage pressure. Wage growth has been weak, but that gives it the potential to come as an economic shock if it starts to strengthen. There has been a lot of political outcry about low wages in recent years, with some states and municipalities acting to raise their minimum wages. On a more market-based front, the current unemployment rate of 5.1 percent is well below the 50-year average of 6.2 percent. If the unemployment rate continues to fall, expect competition for labor to result in higher wage growth. The resulting inflation pressure could lead to higher mortgage rates.
The dollar weakens
The dollar has been strong largely because many of the world’s major economies outside of the US have been weak. Longer-term though, there have been calls internationally to find alternative reserve currencies to the dollar for both political reasons and simply because of a desire to diversify. Should the dollar start to fade, it could mean higher mortgage rates for two reasons. One is that a weaker dollar means more expensive imports and thus is inflationary. Another reason is that any drop in world perception of U.S. creditworthiness could mean that lenders generally will demand higher interest rates from U.S. borrowers.
Default rates climb
Lenders use interest rates to help cushion themselves against borrower defaults, and with default rates having been very low recently, lenders haven’t had to build in much of a cushion. After peaking at 5.67 percent in May of 2009, first mortgage default rates had dropped to 0.76 percent by September of 2015. Any increase in that ultra-low default rate will have lenders scrambling for more protection – and that protection would include higher mortgage rates.
The pull of history
Consider this a catch-all category, since it is impossible to anticipate every factor that could lead to higher mortgage rates in 2016. Until 2009, 30-year mortgage rates had never dropped below 5 percent, and they had never dropped below 4 percent until late 2011. This means that rates are in very unusual territory these days, and when you add up the combination of factors that determine mortgage rates, history suggests that conditions normally dictate much higher rates than today’s.
These threats are no guarantee that U.S. consumers will see higher mortgage rates in 2016. Low mortgage rates have survived similar threats already, so there is no telling what next year has in store. Still, the presence of these threats should serve as a reminder that the cost of borrowing money for a home is usually much more expensive than it is today. A return to normal would make it considerably more expensive to buy a home, and remove much of the flexibility available from refinancing.
In short, if one or more of the above threats comes true, people as soon as next year might be referring back to 2015 as the “good old days” of low mortgage rates.
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