What happens to mortgage rates in a recession?

Recession concerns are back, and for some, that comes with worry for higher mortgage rates. This time, however, it’s unclear how rates might react. If we are in fact in a recession, or heading towards one, are steeper mortgage rates a sure bet?

What is an economic recession?

The quickie definition of a recession is simply two consecutive quarters of falling gross domestic product, or GDP. We saw that happen in the first half of 2022.

But is it really a recession? Officially, the National Bureau of Economic Research defines when recessions start and end. Calling a recession isn’t easy, in part because the two-quarter test is only one of many factors to consider:

• Inflation remains elevated. The annual inflation level hit 9.1 percent in June, the highest rate in more than 40 years. The Federal Reserve has responded with a series of rate hikes for banks to tamp down demand, but so far, that hasn’t calmed the price increases.
• Instead of losing jobs, the labor market continues to expand, with the July jobs report beating estimates, the private sector completely recovered from losses sustained in the pandemic and unemployment at a low 3.5 percent.
• Existing-home sales are down, but prices are up. The median price for an existing home broke $400,000 in May to reach $408,400, according to the National Association of Realtors. That figure kept climbing in June, to $416,000. Meanwhile, sales have fallen for five months straight.
  

How past recessions affected mortgage rates

Whether a recession bears out, mortgage rates have been on a wild path this year. Here’s what we know from past cycle turns:

Looking back on mortgage rates, we can see that, since the 1980s, the 30-year fixed has typically fallen during recessionary periods. While the Federal Reserve sets monetary policy that impacts many types of financial products, fixed mortgage rates instead track the 10-year Treasury yield, a measure that isn’t immune to broader economic forces.

In addition, since recessions come with reduced economic activity and higher unemployment rates, it follows there’d be less demand for mortgage financing. With less demand, interest rates fall.

Today, we have declining economic growth coupled with high employment levels. We’ve also seen mortgage rates on a curious trajectory in the past 18 months:

• At the start of 2021, the 30-year fixed rate stood at 2.95 percent, according to Bankrate’s national survey.
• A year later, 2022 began with the 30-year at 3.4 percent. It then quickly ramped up to 4 percent by mid-February, then 5 percent in April.
• The 30-year came close to 6 percent in June (5.91 percent), but fell back to the mid-5s in July. As of the first week of August, it has settled at 5.55 percent.

Many forecast the 30-year fixed rate to stay in the mid-5 percent range, or slightly higher, for the rest of the year. The fact is, however, the push-and-pull of Fed rate hikes on one hand and inflation on the other make it unclear whether a recession now would cause rates to materially rise or fall going forward.

What happens to your mortgage during a recession?

Fixed-rate mortgages are considered a hedge against inflation because they allow borrowers to lock in their monthly payment, no matter how high mortgage rates climb. If you can continue to make those payments in a recession, you’d be in a much safer position than borrowers who have adjustable-rate mortgages (ARMs), which fluctuate with the market.

On the other side of things, a recession might have an impact on your mortgage servicer’s business. Fortunately, if the company fails, there are protections in place for borrowers. You’ll be notified your loan has been sold to another lender or servicer and where to send your payments moving forward.

How to cope if you can’t make mortgage payments

If financial difficulties arise as a result of a recession or other hardship, contact your mortgage servicer as soon as possible for relief options, such as forbearance or a loan modification.

If you’re in a situation that will quickly be corrected, forbearance is the way to go. With this repayment plan, your servicer allows you to miss some payments now and then adds those to future monthly payments or requires one lump sum. Alternatively, you might be able to arrange for a short-term, interest-only payment plan, with the deficit made up at a future date.

If your situation is permanent in nature, ask for a mortgage modification to change the terms of the loan, such as the interest rate or repayment schedule.

For either of these options and others, contact your servicer right away to see if you’re eligible. Do not stop making payments without communicating with your servicer — if you do, you’ll damage your credit and could set foreclosure proceedings in motion.