00:00At the end of 2024, the U.S. Federal Reserve lowered the federal funds rate to a range of 4.25%
00:06to 4.5%. The Fed has now reduced rates by one percentage point since September 2024,
00:13which was welcome news for home buyers and first-time buyers, hoping this would be a
00:17continued trend in 2025 and that mortgage costs would reduce. But the confusing thing is that
00:23mortgage rates have actually gone up instead of down. Why? In this video, I'll cover the key
00:29reasons why mortgage rates are going up right now, and I'll touch on the outlook for the rest of 2025.
00:36If you're new to this channel, I'm Matt. I've been a finance consultant for over 10 years.
00:40I now run my own company, and on this channel, I talk all things personal finance.
00:45So let's start with what influences mortgage rates. The first concept to understand is U.S.
00:50Treasury bond yields. Mortgage rates are largely influenced by these bonds rather than Federal
00:56Reserve rates. Treasury bond yields is the interest rate that the U.S. government pays to borrow money
01:02for 10 years, and what is happening to Treasury bonds matters because it influences borrowing costs.
01:08Treasury yields often reflect what investors in the financial markets anticipate for economic growth,
01:14inflation, and monetary policy. As you can see from this graph, the average 30-year fixed mortgage
01:19rate and the 10-year Treasury bond yield move closely in sync. When the bond yield increases,
01:25mortgage rates usually go up as well, and over the last three years, we've seen an upward trend in
01:31both. So while the Federal Reserve cut rates in 2024, Treasury bond yields have gone up to almost 5%,
01:38and this is the highest they've been since just before the financial crisis in 2008. This is bad
01:44news for the U.S. government, as it means they must pay more to service their debts, and it's also bad
01:49news for borrowers, including mortgage holders, as mortgage interest rates greatly depend on which
01:54way bond yields are moving. For example, in December 2024, the 30-year fixed mortgage rate jumped to
02:006.72% compared to 6.6% just a week earlier. The rise was tied to changes in the bond market driven by
02:09higher inflation expectations and growing uncertainty in the economy. There are several factors that have
02:15contributed to the recent volatility that we've seen in the bond market. The first is that there have been
02:20concerns about inflation and government economic policies. The U.S. annual inflation rate is
02:25currently at 2.7%. Although it's moving in the right direction, it's still above the Federal Reserve's
02:31target of 2%, and many investors worry that it will be difficult to bring it fully under control.
02:37There's also uncertainty about the new Trump administration and what government policies
02:41could be introduced, such as policies to boost economic growth and tariffs, which could push the
02:47inflation rate further upwards and lead to higher interest rates. At the same time, rising U.S.
02:52federal debts and growing budget deficits has made investors increasingly cautious, which has put
02:58upward pressure on bond yields. The second point is that bond yields rise to attract investors.
03:04Treasury bonds are seen as a safe investment as they're guaranteed by the U.S. government,
03:09but investors tend to turn to higher return investment opportunities, such as stocks and shares,
03:14when the financial markets are growing. The return on the S&P 500 stock market index was around 24%
03:21in 2023. During that time, the average yield on a 10-year treasury bond was less than 4%.
03:28It doesn't take an expert investor to work out which gave you a better return for your money.
03:33As demand declines for 10-year treasury bonds, the bond yield rates rise to attract investors.
03:39And the third point is the uncertainty about the Federal Reserve's next steps. The Federal Reserve
03:45chair, Jerome Powell, recently stated that there will likely be fewer interest rate cuts than expected
03:51in 2025, and this statement unsettled the financial markets and contributed to the rise in bond yields.
03:58It's helpful to understand what drives bond yields, as new mortgage rates change all the time,
04:03but they're roughly in line with the 10-year treasury bond yield.
04:06The second concept to understand that influences mortgage rates is something called the spread.
04:12Mortgage rates are determined by adding a spread, which is an additional fee on top of the 10-year
04:17treasury bond yield. The additional fee is historically around 1.5% to 2% to compensate for
04:24the higher risk of mortgages and loaning money to customers that could default or struggle to make
04:29repayments. So if the bond yield is 5%, mortgage rates could be 6.5%, 7% once you've added the additional
04:36fee. The additional fee started to increase when the Federal Reserve put in place measures to tighten
04:41the economy. And as a result, people taking on new mortgages are paying more, whether that be an
04:47existing mortgage holder who is refinancing their loan or a potential home buyer trying to get on
04:52the property ladder to buy their first home. The spread or additional fee did come down a bit in
04:572024, but still remains far above pre-COVID pandemic levels. If the spread went back to normal levels,
05:04then we may also see mortgage rates come down a bit too. The third concept to understand which can
05:10also influence mortgage rates is mortgage-backed securities. Most lenders don't keep the loans they
05:16fund. Instead, they package them into mortgage-backed securities and sell them to investors. When
05:21mortgage-backed security prices are low, mortgage rates are high and vice versa. The US Federal Reserve,
05:28particularly through the COVID pandemic, bought mortgage-backed securities as part of its
05:32measures to support the economy, keeping mortgage rates for home buyers lower and cheaper to finance.
05:38This measure by the Federal Reserve inflated demand for mortgage-backed securities. However,
05:44as you can see from this graph, over the last couple of years, the Federal Reserve has been reducing the
05:49amount of mortgage-backed securities that they have. And this had a downward trend on their price
05:54and therefore an upward trend on mortgage rates. So what is the outlook for mortgage rates in 2025?
06:00Well, unfortunately for home buyers, mortgage rates probably won't drop enough to substantially
06:06improve affordability. Many forecasters predict that mortgage rates will hover around the 6% range
06:12this year. If you're thinking about buying a home, it's generally better to think about how home
06:17ownership fits into your lifestyle and finances, rather than trying to time the market to get the
06:22best mortgage rate. With mortgage rates looking like they'll be remaining relatively high in the
06:27short term, the decision on whether to rent or to buy or whether to pay off your mortgage early or
06:32to invest becomes increasingly important. I've done videos to deep dive on these topics. So if you want
06:38to understand more, I'll leave links to the videos down below. I hope this video has been helpful in
06:44clearing up some of the confusion about why mortgage rates aren't falling following the Federal Reserve rate
06:49cuts. Feel free to leave any questions in the comments, give the video a like and subscribe to my channel.
06:54I'll see you on the next video.
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