Why Mortgage Lenders Are Raising Interest Rates

Suppose you’ve been following the real estate market lately. In that case, you’ve noticed something a little disturbing: mortgage lenders are increasing interest rates, and this is happening at a breakneck speed. For homeowners, investors, and businesses, this change is akin to a sudden storm after years of calm.

Seasoned professionals in commercial and residential lending markets have observed similar patterns in the past, but rarely with the intensity we’re seeing today. Here’s a look at why this is happening, what it means for you, and where things could go from here.

What’s Driving Rate Hikes?

Rates on mortgages don’t increase in a vacuum. They’re also connected to broader economic dynamics, and at the moment, those forces are clashing in a way that is driving up borrowing costs.

In high-cost markets, even small rate increases tend to have outsized effects. Here’s what’s driving the trend:

1. The Federal Reserve’s Fight Against Inflation

First, the elephant in the room: inflation. The Federal Reserve has been raising its closely watched interest rate aggressively in an effort to dampen the economy.

Since rates were effectively zero as of March 2024, the Fed has hiked 11 times through May 2024 to a 22-year high of 5.25% – 5.5% for the federal funds rate. Though that isn’t directly related to mortgage rates, it has a trickle-down effect. Banks and lenders are borrowing at higher costs, and they pass those costs onto consumers.

Inflation remains stubborn in many regions. For example, the national Consumer Price Index (CPI) held at 3.4% in April 2024, but some areas saw even sharper spikes. For lenders, this means thinner profit margins and greater risk, a recipe for rate hikes.

2. A Red-Hot Housing Market Meets Limited Supply

The demand for housing across many American markets isn’t letting up. Even with rising prices, population growth in major metropolitan areas along with shifting migration patterns post-pandemic has buyers fighting over limited inventory in desirable locations.

According to the National Association of Realtors (NAR), the median existing-home price reached $$403,700 in March 2024, a 2.7% increase from the previous year. Housing inventory, meanwhile, remains at critically low levels nationally, with only a 2.5-month supply of homes on the market far below the 6-month supply considered necessary for a balanced market between buyers and sellers.

When demand exceeds supply, lenders can be more selective. Higher rates filter out less qualified borrowers, meaning only the strongest applicants can qualify for loans. It’s a means to hedge risk in a market where even a modest decline could leave lenders holding overpriced collateral.

3. Commercial Real Estate’s Post-Pandemic Hangover

Residential markets might dominate headlines, but the pressure is actually building in the commercial real estate (CRE) sector. The national office vacancy rate climbed to 18.6% in Q1 2024, according to data from CoStar, while remote and hybrid work arrangements continue to reshape demand patterns. Meanwhile, retail and hospitality sectors are still recovering from pandemic-era losses.

This presents a double challenge for lenders. Vacant properties lead to less revenue for borrowers and raise the risk of loan defaults. In response, banks across the country are hiking rates on new commercial loans and tightening underwriting standards to compensate for these heightened risks.

4. The Ripple Effects of Global Uncertainty

The U.S. housing and commercial real estate markets are not isolated; they’re deeply connected to global economic forces. Geopolitical factors, including ongoing conflicts in Ukraine and tensions in the Middle East, have contributed to rising commodity prices and disrupted supply chains worldwide.

Oil prices remain volatile, with Brent crude priced at about $85 per barrel as of May 2024. These energy costs flow through to construction materials, transportation, and labor expenses, making development projects significantly more expensive nationwide.

Lenders must factor this uncertainty into their calculations. If a new apartment complex is 15% more expensive to build than it was in 2022, lenders will incorporate that risk into their rates, accounting for the potential of cost overruns or project delays that could affect loan repayment.

5. Regulatory Pressures and State-Specific Risks

Regulatory frameworks vary widely across the country, but most markets face some combination of zoning restrictions, environmental reviews, and increasing property taxes that add layers of complexity and expense to real estate projects.

In coastal states, new insurance regulations addressing climate risks have resulted in premiums for properties in flood-prone areas increasing by 20-30% in some regions. Meanwhile, western states are implementing wildfire insurance regulations that similarly increase costs for property owners in high-risk zones.

For lenders, these regional variations in regulatory burden and natural disaster risk increase the likelihood of default or project delays. They respond by raising interest rates, which helps protect against potential losses while ensuring they can continue lending in these more challenging environments.

6. The Impact of Wildfires on Mortgage Rates

The escalating frequency and severity of natural disasters including wildfires in the West, hurricanes along the Gulf and Atlantic coasts, and flooding in numerous regions is another key factor behind increasing mortgage rates nationwide. Recent destructive events have increased risks for lenders and are prompting them to implement tighter borrowing parameters and charge higher interest rates in affected areas.

There are several ways that natural disasters cause mortgage rates to spike:
First, they raise homeowners’ insurance premiums, increasing the costs of insuring and owning properties. A number of insurers have sharply increased rates or even completely pulled out of high-risk areas, pushing buyers into expensive specialty insurance policies.

That extra cost shrinks the number of eligible borrowers, which in turn leads lenders to increase mortgage rates to compensate for some perceived risk. Moreover, values of properties in disaster-prone regions can also be extremely volatile.

Many homes in disaster-affected regions have experienced significant depreciation in property values and plummeting home equity, causing nervousness among creditors about financing homes in these high-risk areas. This greater uncertainty inevitably leads to tightening lending standards and higher interest rates.

What Does This Mean for Borrowers?

If you’re a homeowner seeking to refinance or a company trying to borrow money for a new development, the timing is challenging but not hopeless. Here’s how to navigate in this climate:

• Lock in Rates Early: Rates will likely not decrease too much in the near future. When you get an opportunity, don’t hesitate.
• Get Your Finances in Order: Lenders are rewarding borrowers with high credit scores (720+), low debt-to-income ratios, and large down payments.
• Look into Other Lenders: Credit unions and some private lenders can offer more wiggle room than big banks.

Looking Ahead: Will Rates Keep Rising?

Affordability is a growing concern. With home prices and interest rates both on the rise, even six-figure earners are being priced out. Until supply catches up with demand, a process that could take years, rates will continue to be a barrier for many.

Mortgage rates are rarely a hit, but they’re a symptom of larger economic changes, not the cause. For now, lenders today walk a tightrope: weighing risk in a precarious market while attempting to keep credit flowing.

Whether you’re on the precipice of buying, selling, or holding on for dear life, knowledge is your best line of defense.
The old axiom in real estate is: “Don’t wait to buy; buy and wait.” That patience, in today’s market, may have to last a while longer.

For expert guidance and real estate financing solutions, visit Fidelity Mortgage lenders