Well, they made a run at it. Many analysts believe that the bond and mortgage-backed securities markets are oversold – in plain English, that mortgage rates have popped up too high and too fast.
How high? That’s a good place to start the discussion. At a given price point, conventional mortgage rates are about 0.325% higher than they were before the election. On a $400,000 mortgage, a difference of 0.325% in rate increases a mortgage payment by about $85.
What if you want the same interest rate as before?
At a given interest rate, that translates into 1.000 to 1.500 points in fee; a difference of 1.5 points is equal to $6,000 in up-front costs. You could choose to absorb the rise either in rate or fee, or a combination of both.
On top of the market turbulence, the Federal Reserve is schedule to meet on December 13th and 14th to discuss, among other things, whether to raise short-term rates or not. The speculation was that because of the slowly strengthening economy they would raise rates, but the surprise election results have thrown that assumption into the air. We’ll see, but this is a good time to remind you that the Feds don’t set long-term (i.e. mortgage) rates, only short-term rates.
Now that that’s out of the way…
What is happening to mortgage rates?
Underlying rates – think of these as the wholesale price of your mortgage – jumped after the election and kept rising the entire week after. This last week rates took a bit of a breather starting about mid-day Monday, and were pretty level through Wednesday afternoon but rose slightly on Thursday and Friday. Because of nervousness in the market, retail rates were more volatile, however, and generally moved higher.
If you look at the red line in the chart above – the U.S. 10-year Treasury Bond – you’ll see that after last week’s spike in yield, bonds leveled off – albeit with a small jump at the end of this last week. The blue line – which tracks the wholesale price on prime conforming mortgages – rose more precipitously last week, but stayed fairly level, if volatile, this week.
The green line, which represents the actual interest rate at which real customers locked their loans over the last week – spiked as expected. People who locked after the election locked at a higher rate than at any time since the beginning of this year.
I read numerous sources to gather different viewpoints on rate outlook. One of the best is from HSH Associates. In this week’s email they wrote: “As they are known to do, interest rates may have actually overshot the mark and could have some space to settle back. Yes, the Fed is likely to raise (short term) rates in December…but all of the global issues that helped keep interest rates down through November 8 didn’t magically disappear on November 9 when the election was called. With time and a little space to reassess positions, it’s not unreasonable to think that a leveling of rates is in the offing before long at the very least.”
I agree – they, and lots of folks who are smarter than me believe that bonds and mortgage-backed securities are oversold as I said at the beginning of this article.
How long will it take to correct? I stand by my prediction from last week – rates will begin to move down soon once investors get used to the idea of a Trump administration and figure out how that will impact the economy.
Next, let’s take another look at the other trend that I chart – the gross margin that mortgage lenders charge over their wholesale cost. This is important because it contributes to the rate you actually pay.
You can see from the chart above that the margins rose from late spring to mid-summer during the time when the industry was impacted with a lot more business than expected. (Why have a sale when you can’t handle the business you have?) The margin started moving down slightly in August as the industry began to work through the back log of loans in the pipeline, and continued in September.
In October, as wholesale rates started slowly rising, you can see that lenders let the margin drop a little more. It was still above historical levels, and the industry’s highest profits happen when pipelines are full. Lenders who had staffed up to handle the summer crush were content to take a slightly thinner – but still historically high – margin while waiting for the wholesale rates to settle down after an anticipated Clinton victory.
After November 8th, you can see lenders let their margins leap up for a day or two trying to mitigate risk after the election surprise. It was not just a selloff in bonds that caused retail mortgage rates to jump as high as they did – lenders had to back up their pricing until they understood what was happening. The red line – the 30-day moving average – helps you see that the trend on the margin is moving higher again due to perceived instability risk.
This coming week is Thanksgiving week, so bond markets will be closed for four days – Thursday through Sunday. Since that’s a long time during which almost anything can happen in the news that can dramatically affect interest rates, bond yields generally do not fall – at least not much – during this week, and lenders are very unlikely to improve pricing much, even if the bond market rallies and yields drop below their current highs.
If bond yields are due to drop after Thanksgiving, and mortgage lenders are likely to allow their gross margins to fall in order to keep their pipelines full, mortgage rates are very likely to come down.
So, I don’t see rates improving this coming week; they aren’t likely to get much worse, either. If things unfold “normally” – and “normal” seems abnormal these days – we’ll see steady rates this week and movement downward the next.