12/12/2021 | Casey Fleming | I’m sure you’ve heard – rates were way down, then came up, then went down, and now are coming up again. We are all watching rising interest rates. What most folks don’t see, however, is that rates have not only been scraping historic lows; they’ve been remarkably stable when looked at from an historical perspective.
Let’s take a look at what’s happened over the last year.
Rising Interest Rates Drive Mortgage Rates
If you look at the chart below, you’ll see that the 10-year U.S. Treasury yield dropped in the late summer. Clearly we saw rising interest rates in October, but since then they have been extremely steady since. Let’s focus first on the 10-year U.S. Treasury Bills. While Treasury bonds are not directly related to mortgage rates, they compete for the same investment money as mortgage-backed securities, so they attract the same investors for the same reasons. Treasury bills can be tracked in real time, so they tend to be used as a benchmark for mortgage rates. Looking at the two lines above this line (more on those in a minute) you’ll see they are tracking pretty darn well.
The blue line is the Fannie Mae 60-day yield. When investors invest in mortgages, they do so by buying mortgage-backed securities. They are seeking a particular yield, which varies by the minute. Fannie Mae adds on its margin, and then offers to buy mortgage pool from lenders with the yield they require. You can see that it the yield Fannie Mae demands follows the yield on Treasury bonds fairly closely, albeit somewhat slowly when yield decline, especially when they decline rapidly. The Fannie Mae 60-day yield, as it turns out, is an excellent proxy for the mortgage-backed securities market.
Mortgage Rate Movement
However, T-Bills move up and down rapidly. Compared to Treasury Bond yields, mortgage rates jump up quickly, but settle down slowly. Lenders want to make sure of the market direction before taking chances. It’s easy to notice rising interst rates, but falling interest rates are more subtle. You can see this by comparing the red and blue lines. 10-year Treasury Bonds appear to want to settle down this month, but mortgage yields have having a hard time following them. This won’t last forever. At some point either the 10-Year Bond yield will rise, or mortgage rates will follow them down.
Interest rates appear to be at an inflection point right now. Something is about to change.
To understand the chart above, you simply need to understand that institutional investors put some money into bonds, and other money into mortgage-backed securities. MBSs are more risky and require a higher yield, but generally track bond yields. These two investment vehicles compete for investors’ money. Then the price borrowers pay is driven very directly by a combination of the wholesale cost of money to lenders (via mortgage-backed securities) plus the margin lenders want to earn, which varies over time.
The Margins Lenders Demand Drives Rising Interest Rates
Even more interesting is how lenders have responded in the last year. In 2020 lenders simply couldn’t keep up with demand for loans, so lender margins rose. You don’t have a clearance sale when people are swarming the door, right? In fact, you raise margins to try to slow the demand to where you can handle it. 2020 margins were the highest in years.
But look what happened in the last year. Margins have steadily declined as lenders expanded their operations to try to take advantage of the surge in business, but then business levelled off. We are looking at margins half of what we enjoyed last year, and near our “normal.” This tells us that if wholesale rates don’t go down, we don’t have a lot of room for improvement in the near future.
Remember, though, that the three most important factors in interest rates are inflation, inflation and inflation. Recent inflation data may hold up interest rates for a while, unless they prove to be temporary. Stay tuned.
Read More: Interest Rates and Inflation
Mortgage Apps Rise Heading Into Holidays
According to the Mortgage Banker’s Association (MBA) mortgage applications rose in the week ending on December 3rd, but that was after a large drop in November. Refinance applications surge based on small movements in the interest rate market, while purchase applications tend to fall this time of year naturally.
Where Are Mortgage Rates Going?
If the Treasury Bill yields stay down, mortgage-backed securities (for which the Fannie Mae 60-day yield is a proxy for the purpose of this article) are sure to follow. Lender margins are certainly not going to increase, so if the yields on 10-year Treasury Bonds stays low, expect a small improvement in the pricing for your mortgage before New Years.
Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, Fairway Independent Mortgage
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