Mortgage Rates Too High? (Blame the Fed, Wall Street and Your Neighbor.)

Mila Adams moved to Utah in May with her husband and toddler son to be closer to family, but they didn’t expect to be living with her husband’s parents nearly a half year later.

The couple’s search for a home of their own became a race to stay ahead of the rapid rise in mortgage rates. Each time rates climbed — passing 5, 6 and now 7 percent — the size of the houses they could afford shrank.

“We looked at some new builds and some older homes, but it seems like with every rate hike our buying power goes down, and we have to readjust our budget,” said Ms. Adams, 29, who was looking for a three-bedroom house roomy enough for a family with plans to grow. “The high prices of homes are not going down as quickly as the rates are going up to adjust for that loss of buying power. The prices are just kind of stubborn.”

Once rates crossed 7 percent, the couple’s mortgage pre-approval was rescinded because the costlier loan, combined with her husband’s student debt from dental school, would have pushed their debt level too high.

“We are very conservative with our finances and just want to have room not to be house poor,” Ms. Adams said. “It’s a bit of decision fatigue at this point.”

It’s no surprise that rapid interest rate increases by the Federal Reserve — meant to tamp down inflation and cool an overheated housing market — have pushed up mortgage rates, making it harder for many people to buy homes. Changes in consumer behavior and decisions made by investors on Wall Street are also to blame for higher rates.

Analysts say the average rate on a 30-year fixed mortgage, which crossed the 7 percent threshold recently, could be as much as a full percentage point lower if investors, homeowners and prospective buyers hadn’t been shifting their behavior so sharply in reaction to the Fed’s moves.

“A whole percentage point on your mortgage rate is due to what is going on in mortgage markets,” said Scott Buchta, a mortgage analyst at Brean Capital. “The volatility in the market has been passed through to consumers as well.”

Lenders take into account three different interest rates when deciding what mortgage rate to offer a home buyer.

The base rate is typically tied to the yield — or rate of return — on a 10-year Treasury note, which is used because most people move to another home, prepay or refinance within a decade of getting a mortgage. A second rate is tied to the difference between the yield on those notes and mortgage-backed securities, or M.B.S., which are essentially interest-paying bonds backed by mortgages. In Wall Street parlance, this difference is known as the “spread.”

Finally, there is an additional amount of interest charged that reflects the profits that lenders, servicers and other players make in the mortgage chain.

Here’s what is happening behind the scenes.

Many banks and other lenders don’t hold on to the mortgages they originate. Instead, they package them into bonds that they sell to investors. The payments that homeowners make, including interest payments and prepayments, then flow through to those investors. And the money raised from selling the bonds — a vital source of financing for mortgage lenders — allows lenders to make more mortgage loans.

In normal times, the spread between Treasuries and mortgage-backed securities remains fairly consistent. But that changes when interest rates rise, especially as swiftly as they have now.

Since M.B.S. investors such as insurance companies expect interest rates to keep going up, they also expect people to stay in their homes longer, making them slower to prepay or refinance their mortgages. That changes investors’ calculations of the returns they expect on their holdings over a certain time frame. Rather than stick around, some investors sell the bonds in search of higher returns elsewhere. Others demand higher interest rates from lenders to compensate for the additional risk of holding mortgage bonds.

Therefore, the spread — or the amount bond investors now expect to be paid compared with a Treasury note — widens. So far this year, the spread has more than doubled, to 1.7 percent from 0.7 percent. The wider the spread, the more consumers pay because lenders pass on to them the cost of those increased rates.

It hasn’t helped lenders that two of the biggest holders of mortgage-backed securities have pulled back from the market.

Banks, which are both lenders and holders of mortgage bonds, have been selling those holdings. According to data from the Fed, U.S. commercial banks sold roughly $200 billion of government-backed mortgage securities since the central bank first raised rates in March, a sharp reversal after buying roughly $100 billion from September last year through March.

Another large mortgage buyer, the Fed, is also absent. When the pandemic hit in March 2020, the central bank rushed to prop up financial markets, buying Treasuries and mortgage-backed securities to lower interest rates and support prices in order to resuscitate the financial system. Since June, however, the Fed has been letting mortgage bonds roll off its balance sheet as they mature.

“Support for the market has really stepped back,” said Jason Callan, head of structured products at the asset manager Columbia Threadneedle. “The elephant in the room was the Fed and how aggressive they were, but it’s also U.S. banks. They have not been buyers of mortgages all year.”

With demand for M.B.S. so low, the lenders that package and sell the bonds are offering higher rates to lure investors back. Those higher rates are also passed on to consumers.

The volatility in the mortgage market is hitting real estate investment trusts, or REITs, which are publicly traded companies that originate mortgages and also buy the bonds backed by them. REITs are a relatively small but important part of the market because their M.B.S. purchases go toward helping Americans finance their homes.

Annaly Capital Management, the largest mortgage REIT, recently said its book value — the value of its assets minus its liabilities — had fallen around 15 percent as a result of the sell-off in the mortgage market. For AGNC, another large mortgage REIT, the number was 20 percent.

REITs borrow money to buy mortgage bonds and originate mortgages, and collect interest from what consumers pay on their mortgages — making their money on the difference between the two. This makes them very sensitive to changes in interest rates.

To protect against interest rate changes, REITs buy and sell U.S. government bonds and other securities designed to minimize interest-rate risk. For example, as rates fall, they might buy longer-dated Treasuries to make up for some of the lost interest rate payments from consumers paying off their mortgages sooner.

This year, as interest rates have risen, mortgage REITs have sold some of those hedges, adding to the broad sell-off in Treasuries that also feeds into consumer’s mortgage rates.

“It has not been a market for the faint of heart,” said David Finkelstein, chief executive of Annaly. “The moves we are dealing with, on a daily basis, are nearly double what we are accustomed to in markets.”

These interconnected but hard-to-see movements in the mortgage market have real-world implications. For Ms. Adams and her husband, the prospective home buyers in Utah, higher rates have shrunk the couple’s home budget by as much as 30 percent since June.

“It’s this endless feedback loop,” Ms. Adams said. “Things are moving so fast — it’s hard to make a decision.”