Ever noticed how oil prices can plummet on the news, but when you rush to the gas station to save some bucks, the gas prices haven’t dropped much? It’s the same story with US Treasury yields (think of them as oil) and mortgage interest rates (the gas). Mortgage rates are largely influenced by the latest 10-year U.S. Treasury bond yield and usually move in the same direction. But because there are so many different types of mortgages and other factors at play, mortgage rates don’t always change by the same amount.
When the coronavirus hit, it sent US Treasury bond yields crashing to all-time lows. But now, with inflation soaring, mortgage rates are at their highest levels since 2012. So why don’t mortgage rates move as quickly as US Treasury yields? The answer is risk.
But it’s not the risk you might think of, like the borrower who’s eager to refinance their mortgage to save money and improve their monthly cash flow. The risk is actually felt by the investors of mortgage-backed bonds (MBS), who pay a premium for those bonds and expect to recoup that and more over time, through monthly interest payments from borrowers. Most big lenders package their loans and resell them for income and risk-reduction purposes.
Here’s the catch. As the homeowner paying the mortgage, you’d naturally want to pay off your mortgage faster or refinance your mortgage if you see mortgage interest rates drop. This means the MBS investor who paid a premium for your mortgage hoping to earn higher interest payments for a long time loses out because the premium shrinks or the mortgage is refinanced.
This situation is similar to a homeowner who decides to pay points when refinancing their mortgage to get a lower rate, but who ends up selling the home or paying off the mortgage before its breakeven point. This risk of selling your home sooner than expected is why I prefer a “no-cost refinance.” If you have the time and patience, you should always go for a no-cost refinance if the new mortgage rate is lower.
Let me give you an example. A while back, I got a notice in the mail that my Citibank, 30-year fixed mortgage at 4.625% was being sold to another lender. This was before I developed a preference for adjustable rate mortgages. The new lender gave me a 90-day heads up to swap over the autopay, which I did. The investor of my loan was expecting to earn a nice 4.625% interest rate from me for ideally the 28 years left on the amortization schedule. But only about eight months into paying my new bank, I decided to refinance the mortgage to a 5/1 ARM at 3.375%. The refinance took about three months to complete. The higher the premium the purchaser paid for my 4.625% mortgage, the more the purchaser lost since it only got my higher interest for about 11 months. I ultimately ended up refinancing the mortgage again after five years at no cost down to 2.875% and then paid the entire mortgage off five years later.
If you’re ever confused about why things are the way they are in finance, always put yourself on the other side of the transaction. When rates fall fast, like they do during a terrorist attack, the start of a war, or a health pandemic, the risk of prepayment increases. As a result, mortgage-backed security investors want to pay a lower premium. A refinance boom creates underperformance or losses for their existing book of mortgage-backed securities because more of them are getting paid off through refinancing. Therefore, investors are less willing to pay for mortgages. The key point here is: As the premium investors are paying goes down, the price for borrowers goes up, slightly, in either up-front costs or higher interest rates. As a result, mortgage rates do not fall as much as Treasury yields.
Although mortgage rates have fallen to 8-year lows, I believe there is a ~90% chance mortgage rates across all durations will eventually fall to all-time lows like U.S. Treasury yields. The reason why I don’t think there’s a 100% chance all mortgage rates fall to all-time lows is because banks, like gas stations, make their own bets too. And some banks might just keep their mortgages rates higher on the expectation that Treasury yields will come back up so they can make greater profits. But if they are wrong, they will probably lose a lot of refinance business to their competitors. Which means they will eventually have to lower their mortgage rates as well to stay competitive. Finally, some banks will keep their mortgage rates higher than their competitors simply because they are overrun with business. The lender just doesn’t have enough personnel to handle all the new refinancing demand. Too much demand is partially why my last mortgage refinance took over four months to complete instead of their promised three months.
Just like how it’s difficult to time the bottom of the stock market to purchase, it’s hard to time the bottom of mortgage rates. But unlike with stocks, you know exactly how much money you will save by refinancing a mortgage over a certain period of time once you do the math. You got a bird in the hand. Everybody with a mortgage needs to be having a conversation with a lender today. If you don’t see rates going lower, keep on hunting for the lender that wants your business. Plenty have the staff and the desire to meet your demand!
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. The combination of rising rents and rising real estate prices builds tremendous wealth over the long term. Meanwhile, there are more ways to invest in areas of the country where valuations are lower and net rental yields are higher thanks to crowdfunding.
Check the latest mortgage rates online. You’ll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the better. This way, you feel confident knowing you’re getting the lowest rate for your situation. Further, you can make lenders compete for your business.
