Could the Fed be sending mortgage rates higher?

House made of money

If you’ve been house-hunting, you might want to hurry up and get that loan application in.

The Federal Reserve, the nation’s central bank, could be about to start bowing out of its unprecedented five-year effort to boost the economy by keeping interest rates low.

The first place such a move will be felt is in mortgage rates.

In fact, home loan rates have already climbed about a point since last spring when Fed Chairman Ben Bernanke first suggested the bank's rate-setting committee might act later in the year.

Now “later” has turned into next week, as the Fed is widely expected to announce the shift in policy when its Open Markets Committee meets on Tuesday and Wednesday.

The average cost of a 30-year fixed mortgage now sits at 4.72%, but some analysts are predicting it could climb past 5%, depending on how quickly the Fed bows out.

Those rates are still reasonable from a historical perspective. Borrowers typically paid 5% to 6% for 30-year mortgages during the early 2000s, 7% to 8% during the mid- to late '90s, and more than 10% throughout the '80s and early '90s.

Two charts showing the state of mortgage rates and the unemployment rate over time.Still, 5% would represent quite a jump from the rock-bottom rates of the last few years. In November 2012, the 30-year fixed rate was a record-low 3.31%. Just last May, it was only a little higher at 3.35%.

But here’s the thing about those rates: They were so low, in large part, because the Fed was making an unprecedented effort to keep the U.S. economy afloat.

What the Fed was doing was buying up Treasury securities and mortgage-backed bonds – to the tune of nearly $3 trillion since the financial crisis hit in 2008. This essentially flooded the lending market with money, which kept interest rates down.

It was part of an overall effort to make credit cheap, encouraging businesses to invest and consumers to buy homes and other things until the economy started to regain its health.

This summer, Bernanke signaled the Fed feels the economic recovery is far enough along and unemployment, which fell to 7.3% in August, is declining enough that the central bank could soon begin scaling back its purchases of these bonds and securities.

Bernanke said the Fed sees unemployment falling to 7% next summer, at which point the purchases would end.

Mortgage rates then would be determined as they had been before the intervention, through a market where mortgages are bought and sold by investors.

Where would rates end up? No one can say for sure. It depends on housing demand, the strength of the economic recovery, the level of inflation and other factors.

But it’s way too early to start fretting about next year’s mortgage rates. There are better things to fret about directly ahead that could derail Bernanke’s scenario.

First, the Fed’s decision to scale back its purchases may be widely expected, but it’s not certain. Bernanke has signaled strongly this is the direction it is leaning. But there is resistance within the Fed leadership.

Some members feel unemployment should fall further before the Fed changes direction. Although unemployment did drop another tenth of a percent in August, job growth remained anemic, possibly lending strength to that position.

Second, our divided and largely dysfunctional government is facing two different deadlines that could dampen or even derail the economic recovery, unless Democrats and Republican can find a way around their differences.

That uncertainty could cause the Fed to hesitate or even change plans.

Congress reaches the first deadline just 12 days after the Fed meeting. On Sept. 30, the government will run out of authority to spend money unless lawmakers pass something called a “continuing resolution” that allows it to keep functioning.

Without a resolution, the possibility of a government shutdown looms. If you feel like you’ve heard this before, you have. It’s become a regular ritual on Capitol Hill.

But each time, it risks setting back the economy. This time, the Tea Party wing of the Republican Party wants to use the threat of a shutdown to “defund” Obamacare, essentially killing the health care law by starving it of operating money.

The president and Senate Democrats are never going to let that happen. The question is how far House Republicans feel they have to push the matter to keep their supporters happy.

Most political observers believe Republican leaders will hang on until the last minute to see if they can extract any concessions out of President Obama before giving in.

But the problem with this brinksmanship is there’s always a chance a miscalculation could send things over the cliff. Shuttering the government, even briefly, would send a negative jolt into the economic recovery.

If we manage to avoid that cliff, another one looms directly ahead.

The U.S. government will reach its legal limit to borrow money in mid-October. If lawmakers don't agree to raise this “debt ceiling,” the U.S. risks defaulting on some of its obligations.

Once again, we’ve been here before. Based on a similar showdown in 2011, an impasse is likely to rattle financial markets worldwide, unnerving business and industry and causing them to hold back on hiring or significant spending until they get a clearer picture of what’s ahead.

It’s just what a still-shaky economic recovery doesn’t need.

Yet for now, Republican House Speaker John Boehner is saying any increase in the debt ceiling must be accompanied by more cuts in federal spending. President Obama says raising the ceiling is a separate issue – a matter of honoring past obligations – and vows not to negotiate.

In his comments this summer, Bernanke stressed the Fed could shift its plans based on changing economic circumstances. Over the next month and a half, we’ll all get a much better idea of how those circumstances might change.

Mortgage rates are only one of many economic factors likely to be effected by what happens.

It all starts with next week's Fed meeting.

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