Mortgage rates ended the year near a record low. Will the record-shattering mortgage rates continue in 2021?

Mortgage rates plummeted to historic lows this year, with the rate seemingly topping itself every week. As the year comes to a close, the average rate for a 30-year fixed-rate mortgage sits at 2.67 percent, more than a full percentage point lower than the end of 2019.

Sam Khater | Photo credit: Freddie Mac

How did mortgage rates get so low and will they rise in 2021?

“All eyes have been on mortgage rates this year, especially the 30-year fixed-rate, which has dropped more than one percentage point over the last twelve months, driving housing market activity in 2020,” Sam Khater, Freddie Mac’s chief economist, said in a statement.

Rates have been steadily falling for the year leading up to the pandemic, as the Federal Reserve has been consistently lowering interest rates to support a weakening economy. As the pandemic raged and the economy was all but shut down, the Federal Reserve’s Open Market Committee moved rates to zero percent, to fuel economic growth.

The initial spike in massive demand led to a backlog of home purchases and mortgage lenders couldn’t keep up, which meant increasing mortgage fees that are baked into the mortgage rate. That, in part, kept the mortgage rate from falling too fast in the early days of the pandemic.

At the same time, Powell and the Fed have continued to engage in high levels of quantitative easing, pumping liquidity into the mortgage market through the purchase of mortgage-backed securities. The Fed owns more than $2 trillion in mortgage-backed securities.

Data courtesy the Federal Reserve Bank of St. Louis

The aim of the Fed’s purchase goals is to achieve a higher rate of employment while also pulling the levers of price stability through inflation. In a statement in mid-December, the Fed announced it remained committed to keeping the target range for the federal funds rate at 0 percent to 0.25 percent until employment and inflation goals are met.

“In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the committee’s maximum employment and price stability goals,” The committee said, in a statement. “These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”

The pace of mortgage rate declines has far outpaced the level of declines seen in the past, according to Len Kiefer, the deputy chief economist at Freddie Mac.

The average 30-year fixed mortgage rate has typically dropped about two percentage points per decade, since 1981. In the past year, the rate has fallen more than an entire percentage point.

Economists, for the most part, aren’t expecting a huge spike in mortgage rates, as we head into 2021.

“Heading into 2021 we expect rates to remain flat, potentially rising modestly off their record low, but solid purchase demand and tight inventory will continue to put pressure on housing markets as well as house price growth,” Khater said in a statement.

Lawrence Yun, the chief economist at the National Association of Realtors, expects that mortgage rates will climb back up to around 3 percent in 2020, which is still far below the level rates were at prior to the pandemic.

The official NAR forecast, which includes predictions of more than a dozen economists, also predicts the average rate for a 30-year fixed-rate mortgage will rise to 3 percent in 2020 and 3.25 percent in 2021.

One potential stumbling block for the record-low mortgage rates would be an unexpected rise in inflation, which was something Yun cautioned over the summer when the Fed initially made it clear that rates would stay at zero for the foreseeable future.

“If inflation, for an unexpected reason, should pop up, then mortgage rates will rise independent of the Fed as lenders need to compensate for the loss of purchasing power of the dollar, which happened during the 1970s,” Yun said, in June.

Low mortgage rates, for the most part, have done their job in fueling an extremely hot housing market. They have also been a major contributing factor in fueling the high price growth, according to Daryl Fairweather, the chief economist at Redfin.

“I expect that to continue into early 2021,” Fairweather said on Twitter.

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