Rising Oil Prices Push Mortgage Rates Higher—What Homebuyers Should Know

Potential homebuyers hoping for a smooth entry into the spring market are facing a renewed headwind: rising mortgage rates. As of Thursday, the average rate for a 30-year fixed-rate mortgage clocked in at 6.35%, according to Mortgage News Daily. This represents a jump from 5.99% just two weeks prior, a shift largely attributed to escalating concerns about inflation fueled by geopolitical instability and, specifically, oil prices.

The connection between oil prices and mortgage rates isn’t coincidental. Lawrence Yun, chief economist for the National Association of Realtors, succinctly puts it: “High oil prices are not good for mortgage rates.” The recent surge in oil prices stems from disruptions to global supply following military actions in the Middle East, particularly constraints on oil flow through the Strait of Hormuz, a critical maritime channel in the Persian Gulf. Brent crude, a global oil price benchmark, spiked to as high as $119.50 per barrel on Monday, a significant increase from approximately $70 before the recent conflicts. As of Friday morning, it was trading around $100 per barrel. Brent crude’s volatility is directly impacting the cost of borrowing.

Stephen Rinaldi, president and founder of the Rinaldi Group, a mortgage broker based near Philadelphia, explains the mechanism: “The Iran conflict — that’s a major headwind for mortgage rates. We don’t know how it’s going to shake out. Oil drives inflation, and inflation drives rates.” When investors anticipate higher inflation, they demand a greater return on long-term investments like bonds, pushing up yields. This, in turn, influences mortgage rates. The 10-year Treasury yield, currently around 4.25% as of Friday morning, has risen from below 4% before the outbreak of conflict in the Middle East, according to CNBC.

While the current rate of 6.35% is a concern for prospective buyers, it’s important to contextualize it. A year ago, the average rate was higher, at 6.82%, and in October 2023, it reached approximately 8%. Affordability, while still a challenge, has shown some signs of improvement. Yun notes that the market is “so much better for buyers this spring compared to last spring,” citing increased inventory and homes staying on the market longer, giving buyers more negotiating power.

In February, the median price for a single-family home was $401,800. Based on this price and an average mortgage rate of 6.12% (the February average), buyers would need an income of $93,696 to qualify for a mortgage, according to the National Association of Realtors’ Housing Affordability Index. This assumes a 20% down payment of $80,360. This qualifying income is lower than the $101,616 required a year earlier when the average rate was 6.92% and the median home price was $400,900.

For buyers concerned about further rate increases, there are strategies to mitigate the risk. The standard practice is to “lock in” an interest rate once a purchase agreement is signed. This guarantees that rate for a set period, typically 30 or 60 days, provided the buyer’s financial situation remains stable. However, locking in a rate means missing out if rates subsequently fall.

Rinaldi advises consumers to inquire their lender about options if rates do decline after locking. Some lenders offer a “float down” provision, allowing buyers to take advantage of lower rates if they fall by a specified amount before closing. Alternatively, buyers can choose to “float” the rate, leaving it unlocked until closer to the closing date. This carries the risk of rates rising, but also the potential benefit of securing a lower rate. Be aware that lenders may charge additional fees for these rate-float options.

While oil prices are a significant driver of current rate volatility, they aren’t the sole factor. Broader economic indicators, such as inflation data and the Federal Reserve’s monetary policy decisions, also play a crucial role. The Federal Reserve’s upcoming March meeting is being closely watched for signals about potential interest rate adjustments. The ongoing conflict in Iran also heightens affordability issues ahead of that meeting.

The interplay between these factors creates a complex and dynamic environment for homebuyers. The recent increase in mortgage demand, despite the rate volatility, suggests that some buyers are still willing to enter the market, perhaps anticipating that rates will stabilize or even decline in the future. CNBC reported that weekly mortgage demand increased despite the recent volatility.

Yun now anticipates mortgage rates around 6.5% if the conflict in the Middle East persists or oil prices remain elevated, a revision from his earlier forecast of 6%. The trajectory of oil prices, and by extension, mortgage rates, will largely depend on the resolution of the geopolitical situation. Buyers should carefully consider their risk tolerance and financial situation before making a purchase. Exploring different mortgage options, understanding the potential for rate fluctuations, and working with a knowledgeable mortgage professional are crucial steps in navigating the current market.

The coming months will be pivotal. Monitoring oil prices, inflation data, and Federal Reserve policy will be essential for both buyers and sellers. While the housing market faces headwinds, the improving affordability and increased inventory offer some encouragement for those looking to enter the market this spring.