Where are mortgage rates headed?
That is the most frequently asked question being thrown my way of late. In this column I’ve got some answers.
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Mortgage rates are going to stay high for the foreseeable future. Don’t be surprised if the average Freddie Mac 30-year fixed rate mortgage hits 7% by year’s end.
This week it rose to 6.66%. So, 7% is in sight.
Mortgage food chain unpacked
When a mortgage lender, be it bank, credit union or a non-depository mortgage banker funds your loan, it’s always from a huge line of credit, sometimes called a warehouse line.
Usually, the funding lender sells the loan to a government agency or a government-backed agency like Ginnie Mae, Fannie Mae or Freddie Mac or some non-governmental financial company.
The agency or institution bundles a plethora of mortgages together creating what is called a mortgage bond. Investors can eventually buy into this relatively safe income producing investment (due to the implicit government guarantee for the interest being paid). More broadly, mortgage bonds are called MBSs or mortgage-backed securities.
As homeowners make their principal and interest payment, the bond investor receives its portion of the bond fund in monthly intervals. That income is generated from the monthly mortgage payments being paid by the homeowner.
All the home loans bundled into the MBS use the underlying properties that were borrowed against as collateral in the event the homeowner fails to pay. That’s a second reason why mortgage bonds are considered safe investments.
As an aside, the reason why the 2008 housing market blew up with millions of foreclosures during those mortgage meltdown days is because of all the upside-down sub-prime mortgages. Many homeowners stopped paying their monthly mortgage payments and walked away. Most owed more than the property was worth. So, there was little or no collateral protecting the mortgage bond investors, making billions of dollars’ worth of private-label (non-governmental) bonds almost worthless.
The government backed mortgage bonds (Ginnie Mae, Fannie Mae and Freddie Mac) continued to pay out each month even though millions of conventional and FHA/VA borrowers also defaulted. Uncle Sam was the downstream guarantor, stepping in — taking over Fannie and Freddie in conservatorship — and providing the funds to pay the bondholders.
Now, let’s go to a more granular, 30-year fixed mortgage interest rate factory.
Even though most mortgages are amortized over 30 years, the mortgage lending world tracks or benchmarks to the 10-year Treasury bond, not the 30-year Treasury bond. Both are long-term debt issued by the U.S. government.
Currently, 30-year mortgage rates are running about 2% higher than the 10-year Treasury bond.
Think about a teeter-totter. Bond prices and interest rates move inversely or in opposite directions. When market interest rates rise, bond prices fall. When interest rates fall, bond prices rise.
Below is a simple example, when the bond price goes up, the yield goes down.
Let’s say you loan me $1,000 for 10 years (like a bond) to start an artificial intelligence company. I agree to pay you $100 interest each year for loaning me the money. I will still owe you the $1,000 of principal in addition to the annual interest payments. Your rate of return or yield is 10% ($100 divided by $1,000).
A year later, my company is established and doing well (less risk of default than one year ago). People are now willing to loan me $2,000 for the same $100 interest payment. The yield drops to 5% ($100 divided by $2,000).
Below is a simple example of when the price goes down, the yield goes up.
In year three, my AI company is tanking, losing all kinds of business to larger competitors. I will now pay $100 of annual interest for a $500 loan. The yield jumps to 20% (100 divided by $500).
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Mortgage interest rate translation
Bond prices go up, yield goes down and mortgage rates go down.
Bond prices go down, yield goes up and mortgage rates go up.
Mortgage bonds can and do compete (for investor capital) with the $40 trillion national debt (the U.S. spends more than $1 trillion a year just to service the debt) needing more financing. And competing for the huge AI appetite among many others looking to borrow big money. There is big demand for mortgage bonds due to the higher yield on the investment. Higher yields mean consumer mortgage rates go up.
What can you do about today’s high rates if you need a mortgage?
Consider a 30-year mortgage that adjusts after five or seven years. Comparatively, adjustable rate mortgage prices are cheap at rates in the low and medium 5% range for prime borrowers. That’s about 1% lower than the fixed rate market.
Hopefully, things will be different within five or seven years to refinance it into a cheaper fixed rate.
A 30-year fixed-rate temporary or permanent buydown is another financial instrument to beat down today’s higher interest rates.
Ask a friend or relative to privately finance your mortgage at a lower interest rate. I recently lost out on a mortgage sale where a relative did so at a much better rate than I was able to offer.
You might be able to borrow money against your retirement savings or stock funds.
You can always wait it out and not borrow in the near term.
Note: I am not an investment adviser. Please check with your advisers first if you are considering a bond market investment.
Freddie Mac rate update
The 30-year fixed rate averaged 6.66%, 1 basis point higher than last week. The 15-year fixed rate averaged 5.98%, 4 basis points higher than last week.
The Mortgage Bankers Association reported a 1% mortgage application decrease compared to one week ago.
Bottom line: Assuming a borrower gets an average 30-year fixed rate on a conforming $832,750 loan, last year’s payment was $55 less than this week’s payment of $5,351.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.99 %, a 15-year conventional at 5.75 %, a 30-year conventional at 6.375%, a 15-year conventional high balance at 5.99% ($832,751 to $1,249,125 in LA and OC and $832,751 to $1,104,000 in San Diego), a 30-year high balance conventional at 6.625% and a jumbo 30-year-fixed at 6.375%.
Eye-catcher loan program of the week: A 30-year mortgage, 30% down, 5.5% for the first five years payments, and 1 point cost.
Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or [email protected].
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