7/29/2019 | Casey Fleming | You have heard that mortgage rates have come down recently. The question on many folks’ mind is how far they come down, why, and how long will it last? Let’s start by looking at mortgage rates today.
Mortgage Rates Are at a Three-Year Low
Rates have fallen slowly but steadily all year, and hit their lowest point in almost three years right around the third week of June, after the Federal Reserve’s last meeting. The chart below tracks three different measures of interest rates:
- The 10-year U.S. Treasury Bills measures the yield institutional investors demand for U.S Treasury certificates due in 10 years. In other words, it’s the yield investors are comfortable with lending the U.S. government for 10 years.
- The Fannie Mae 60-day yield is the interest rate that Fannie Mae is offering to mortgage lenders for mortgages that are delivered to Fannie Mae within 60 days for sale. Think of this rate as the wholesale cost of mortgages for lenders. Of course, lenders have to add a margin to make a profit, so,
- The Freddie Mac Mortgage market Survey is a backward look at the interest rates consumers actually locked their loan in at over the previous week. So, it reflects the margin that mortgage lenders are making. You’ll notice that margin goes up and down over time; more on that later.
The first thing you’ll notice is that mortgage rates today have dropped, and are at their lowest rate since before the election in 2016. (There has been a very slight bump upward since the third week of June, but they will turn back down again, in our opinion.) Why do we think that?
The best place to start is to remind ourselves that the three most important factors in mortgage rates are: inflation, inflation and inflation. (Or rather the expectation of inflation.)
Related: What Drives Interest Rates?
What has happened this year is that the fear of inflation (which drove rates up over the last two years) has diminished. Fears have been further calmed by assurances from the Federal Reserve (arguably the smartest minds in the room) that inflation is in check. With a lower perceived risk of runaway inflation, investors can lend money out for longer periods at lower interest rates.
So, mortgage rates have come down – to very low levels.
Where will interest rates go the rest of 2019?
While no one has a crystal ball, a consensus is building among the best analysts in the country that inflation is, indeed, in check. The economy has slowed and there is even some risk – though slight – of recession, so investing in the stock market may feel a little riskier these days to an investor. With inflation in check, a lower yield on long-term debt, such as mortgage-backed securities, still seems like a pretty good deal to institutional investors.
We expect demand for bonds to remain strong, keeping pressure on interest rates to move downward. However…
One factor that is not often discussed is that the Federal Reserve holds $1.5 trillion (not a typo) worth of mortgage-backed securities. Remember Quantitative Easing? That was the Federal Reserve’s most successful tool for injecting money into the economy in order to juice it.
During that time, they purchased trillions of dollars worth of U.S. Treasury Bonds and mortgage-backed securities. They never intended to hold these investments forever, but they couldn’t sell them all at once either, for fear of crashing the markets. For the last few years they have been selling them off at various rates. In the last year, they have sold off $195 billion worth of mortgage-backed securities, or about $16.25 billion per month.
This is important, because institutional investors can buy newly-issued mortgage-backed securities, or those previously issued that are offered on the open market. So, when seasoned securities are offered they compete with newly-issued securities, which reduces the downward pressure on interest rates today.
The Fed is likely to continue selling off their holdings this year, so that mitigates the expectation of a decline in interest rates at least a bit.
However, we’ve been talking about wholesale rates, which is not what you pay. Lenders – as mentioned above – add a margin to their wholesale cost of mortgage funds, and that margin changes over time. When lenders are busy the margin tends to rise. (Why have a sale when you can’t service all the customers you have in the store?)
During busy times, lenders tend to increase their staff to take advantage of the business. When they’ve caught up with their pipeline, they tend to reduce their margins in order to keep their staff busy.
Take a look at the chart above. This chart tracks the difference between the Fannie Mae 60-day yield (a proxy for the wholesale cost of mortgage funds) and the Freddie Mac Weekly Mortgage Market Survey (a measure of the interest rates people actually locked at over the previous week.) You can see that as the market slowed down 2016 through 2017 margins decreased fairly steadily. By December 2018 – a very slow month for originations – margins were at their lowest rate in years.
But mortgage rates in 2019 have surprised us all by going lower and lower. The total industry volume picked up, and by May lenders were so busy they couldn’t handle the extra volume. Margins shot up to their highest level in years, albeit briefly. Lenders were staffing up, and by the end of June you can see they caught up with their backlog, and started getting hungry for business again. Retail margins appear to be moving down steadily now.
Because mortgage rates today are so low we expect 2019 to be busier for the rest of the year than it was in 2018, so margins are not likely to come down as low as they were last year. However, a return to 2017 margin levels would yield a reduction in interest rates of about 0.15%, even if the wholesale rates don’t move.
Looking at the whole picture, it seems highly likely we will see a slow, unsteady decline in interest rates for the rest of the year, but the decline will not be a dramatic one.
What will the Feds do on July 31st?
The Feds meet again July 30th and 31st, and will issue a statement on the 31st. At the beginning of this year they were expecting to raise short-term rates (NOT the same as mortgage rates) two or three times in order to hold inflation in check. By their June meeting they had turned their thinking around, and announced they were considering lowering short-term rates in order to prevent the economy from going into recession. They did not lower rates in June, however.
Many analysts – if not most – now believe they will lower short-term interest rates by 0.250% when they meet in July. This is widely anticipated, and so probably won’t affect the yields on mortgage-backed securities (represented by the Fannie Mae 60-day yield in the first chart.)
How Do I Know if it’s a Good Idea for Me to Refinance?
The time to ask this question is the first time you think of it. We say this not because you should, but because you should know. Most lenders use a payback analysis to “prove” to you that you will save money with a refi. Please don’t fall for this – the math is wrong.
For a detailed discussion of a better way to look at this question, and for free tools that can help you decide if it makes sense for you, read my article on the subject.
How Will Lower Rates Affect Home Prices?
This is a long discussion, and will be the topic of my next article.
Source for Federal Reserve Balance Sheet Data: https://www.federalreserve.gov/releases/h41/current/h41.htm
Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, C2 FINANCIAL CORPORATION
My Blog: www.loanguide.com
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This article represents the opinions of Casey Fleming, and not necessarily those of C2 Financial Corp. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial Corp., have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor C2 Financial Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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