It’s bound to happen eventually. The way that home loan rates have dropped over the past couple of years has been staggering. The rate for a 30 year fixed rate mortgage, for example, hit an all time low back in April of this year, and today that rate is less than half a percentage point higher.

Still, there is speculation that this is all about to change. Consistently, the Federal Reserve has been lowering interest rates as inflation has not been much of a concern. However, most experts suggest that the Fed will be raising rates which will, in turn, make home loans more expensive.

There’s another way, however, that the Federal Reserve is influencing housing prices. The Fed buys a certain amount of mortgage-backed securities, also known as MBS. An MBS is a grouping of home loans that are pooled together and then that are sold as a bond.

How MBS Work

Here’s how an MBS comes into being. When you get a mortgage, the bank gives you money in exchange for putting your home up for collateral on the home loan. The bank or mortgage broker may then sell your loan to an entity that will put your loan into a pool with other loans. These loans will be of various types and maturity dates. The company that aggregates these loans will then issue bonds (the MBS) that offer a stream of income for the buyer.

The companies that buy the mortgages and aggregate them are government sponsored entities. Some of these, such as Fannie Mae and Freddie Mac, have experienced trouble in the past few years. Others, such as the Federal Home Loan Banks, have fared better.

What the Federal Reserve did to fix MBS

One of the problems with the housing market is that no one was wanting to buy MBS. This meant that the supply of new mortgage loans was slowed. As a part of its efforts to try and get the economy going again, it purchased $500 billion in MBS. By March of 2009, they increased this to a goal of $1.25 trillion. These purchases by the fed have helped the MBS market stay liquid, and have kept rates low.

Transition from Fed to private investors

Experts believe that the fed will stop buying MBS once it hits its goal. This prop that had been holding up the market will be knocked out. What remains to be seen is how other investors will then react. The fed will first slow down its buying of MBS and then eliminate it altogether.

Some experts believe that private investors will ask for a much higher interest rate on MBS. This will then lead to higher rates on mortgages. The real question that remains, however, is how fast they will rise and how high. On those points, no one can be certain.