Democrats and Republicans have two days to reach a deal before the government breaches the debt ceiling. Should a default occur, mortgage applicants could face a worst-case scenario that includes rates that rise by as much as one to two percentage points within a day or so, says Stu Feldstein, president of mortgage-research firm SMR Research. “Interest rates would go through the roof immediately,” he says.
In order for such a spike to occur — and last more than just a few days — several scenarios would have to play out. Besides defaulting on its debt, the U.S. government would have to signal that it isn’t planning on making its payments soon or it would have to take the position of not intervening to stabilize the mortgage market. Analysts say complete inaction is unlikely since a severe increase in rates would lead to a drop in mortgage applications that would stall the housing recovery.
Home buyers, however, should be aware of the link between a government default and mortgage rates. A default would lead to an increase in Treasury yields, which serve as a benchmark for determining rates on many mortgages. The Treasurys impacted first would be those with the shortest-term duration—which would make adjustable-rate mortgages more expensive for borrowers, says Brad Hunter, chief economist at Metrostudy, a housing market research and consulting firm. These loans are given to borrowers with an initial teaser-like rate, which is normally fixed for a number of years; once that rate becomes variable, it’s often pegged to the one-year Treasury yield. That yield has barely budged in the last couple of weeks, though experts say a default would send it climbing.