Here's why mortgage rates dropped to their lowest level in more than a year

Source: Here's why mortgage rates dropped to their lowest level in more than a year - ABC News (go.com)

By: Max Zahn

The average rate for a 30-year fixed mortgage stands at 6.47%, data shows.

Mortgage rates this week dropped to their lowest level in more than a year, delivering some long-sought relief for homebuyers.

The average interest rate for a 30-year fixed mortgage stands at 6.47%, Freddie Mac said on Thursday. That figure marks a drop of more than a percentage point from a peak attained last year after the Federal Reserve hiked interest rates in an effort to fight inflation.

The Fed has held interest rates steady at their highest level in two decades, however. So, why are mortgage rates plummeting?

Experts who spoke to ABC News attributed the drop to a widely held expectation that the Fed will begin to cut interest rates at its next meeting in September. A weaker-than-expected jobs report last week bolstered those expectations, triggering a drop in yields for 10-year treasuries, which in turn sent mortgage rates plummeting, they added.

The yield on a 10-year Treasury bond, or the amount paid to a bondholder annually, fell sharply last week after the Fed signaled a coming interest rate cut and a disappointing jobs report days later appeared to affirm such expectations. Mortgage rates closely track the movement of 10-year treasuries.

"These 10-year treasury rates are going to directly translate into lower mortgage rates, part of which we're observing in the recent data," Julia Fonseca, a professor at the Gies College of Business at the University of Illinois at Urbana-Champaign, told ABC News.

The chances of an interest rate cut in September are all but certain, according to the CME FedWatch Tool, a measure of market sentiment. Market observers are split roughly down the middle about whether the Fed will impose its typical cut of a quarter of a percentage point or opt for a larger half-point cut.

"That jobs report made markets reevaluate the path of future interest rate cuts," Lu Liu, a professor at the Wharton School at the University of Pennsylvania who studies real estate, told ABC News.

"Because the mortgage rates are priced off of current treasury rates, the treasury rates have already incorporated these expectations for future rate cuts," Liu added.

Experts disagree about the outlook for mortgage rates, since the trajectory depends on future economic performance and the Fed's response to it, which can prove difficult to predict, they said.

The economy has been gradually cooling for months, alongside falling inflation. The U.S. has repeatedly defied previous warnings of an impending recession, though economists disagree about whether current conditions pose an impending risk.

Stijn Van Nieuwerburgh, a professor of real estate at Columbia University Business School, said he expects the economic slowdown to continue. That will trigger interest rate cuts and falling mortgage rates, he added.

"We've reached peak interest rates," Nieuwerburgh told ABC News. "Mortgage rates are likely to come back down for the next several years."

However, he acknowledged the difficulty of predicting economic outcomes and the possibility of a reversal that could lead to interest rate hikes. "Never say never," Nieuwerburgh said.

Liu, of the University of Pennsylvania, said market observers will closely watch incoming data to determine whether the recent jobs report is part of a larger trend indicating an accelerated economic slowdown.

"People are concerned that the risk of a hard landing has increased," Liu said. "Right now, it's a wait-and-see moment."

Still, the current drop in mortgage rates may not rekindle the housing market, experts said, citing a phenomenon known as the "lock-in effect."

While mortgage rates have fallen, they remain well above the rates enjoyed by most current homeowners, who may be reluctant to put their homes on the market and risk a much higher rate on their next mortgage. In turn, the market could continue to suffer from a lack of supply, keeping home prices at elevated levels, said Fonseca, of the University of Illinois at Urbana-Champaign.

As of March, roughly 60% of homeowners carried a mortgage rate at or below 4%, Fonseca added.

"We still might see those borrowers reluctant to give up those mortgage rates," she said. "If they're locked in, we might not see very much movement."