What’s Up With Mortgage Rates?

I wouldn’t expect anyone outside the world of mortgage financing to have tracked the fall, then rise, of mortgage rates over the past 2 weeks. Rates dropped to their all-time low, and before you could say yay! rates jumped up higher than what they were prior to the fall of the stock market. I have received so many phone calls this week from eager people requesting a rate quote – only to be shocked that rates aren’t still at historic lows. Everyone has asked why, so I will do my best to explain where we are at, why we are where we are at, and if you missed the boat.

Why did rates drop in the first place?
Rates dropped partially because of what happened in the stock market, but mortgage rates dropped primarily because of a fear the coronavirus would slow global economies and create a recession. Recessions reduce concerns of inflation. In recessions, prices drop, which is the opposite of inflation raising the prices of goods and services. Inflation is bad for bond holders. In inflationary times the underlying value of the bond is eroded away by inflation. To counteract this, a bond must provide a higher interest rate.

Why did rates move back up?
The concerns of a global recession are greater today than what they were a week ago, so mortgage interest rates should still be at all-time lows. But they are not. Rates have risen because of several factors. I’ll try and elaborate on the main ones.

Too Much Supply:
The great majority of mortgages in this country are eventually sold to Fannie Mae and Freddie Mac. No matter who originates your loan, being a local bank like Bank of Hawaii or First Hawaiian, or a huge national lender like Quicken Loans or Bank of America, if your mortgage balance is at or below the “conforming loan limit” your loan will likely be sold to Fannie or Freddie.

The mortgages Fannie and Freddie receive are packaged together and converted into bonds known as Mortgage Backed Securities (MBS). Every trading day Fannie and Freddie sell these bonds to investors on the open market. The funds they receive are used to buy the mortgages from the banks that funded your mortgage transaction. If you haven’t already followed the bouncing ball, the money to fund your mortgage came from a bank or lender, who sold your loan to get their money back to lend out again. In the end it’s the investors on Wall Street buying MBS that make the whole process possible.

Think of Fannie and Freddie like a company that manufactures widgets. Everyday they go to market to sell their widgets (MBS). In the true spirit of capitalism, bond traders haggle with each other over the price the bond buyers are willing to pay for the product (MBS). The price negotiated reverberates all the way back to the interest rates set by Fannie and Freddie on the loans they will purchase from banks and other lenders.

Here’s the really important part…..

No matter how many widgets (MBS) Fannie and Freddie have to sell each day, they have to sell everything they have. Why? Because tomorrow they will have a fresh batch of MBS to sell. When you run into situations like the flood of new mortgages pouring into the pipeline like we just had, Fannie and Freddie can’t just sit on them and wait for a better day to sell. They must liquidate everything every day. What happens when a supplier tries to sell more of something than the public has an appetite for? They must make the price more appealing to attract more buyers. In the world of bonds that means a higher interest rate for that bond. If, in order to sell MBS, Fannie and Freddie have to offer higher rates, that will result in higher rates offered to you by your mortgage originator.

Lender’s Pipelines are Full:
Lenders are required by Federal regulation to meet certain timetables when they accept your mortgage application. When lenders are flooded with new applications, they don’t have the ability to emergency hire a bunch of people of people to help with the glut. The only way they can slow the flow is to artificially raise the rates they offer the public. This is not price gouging. It is a subtle way for lenders to say they don’t want any more business coming in. It is the converse when times are slow and lenders are willing to take smaller margins and offer better rates than their competitors.

Early Payoffs:
The servicer of a mortgage loan is the entity that collects your payments and pays your taxes and insurance, if your loan has impounds. They are not the owner of your mortgage – they only service it for the investors that bought them from Fannie and Freddie on Wall Street. The bond holder pays the servicer a fee to provide their services. When you refinance that existing loan, it gets paid off and is gone. The fee collected by the servicer ends. When a large number of loans serviced unexpectedly get paid off it will create a financial loss for the servicer. Many banks have their own servicing departments. For them, one way to help make up for the loss of revenue from early pay offs is to increase their profitability of the new loans coming in. That means higher rates for new loans to help mitigate the loss on the loans being paid off.

Liquidity:
As you may have guessed, when stock market suffers losses like they have these past two weeks there are some out there being hit with margin calls. Margin calls are a request for someone who bought stocks on credit (margin) to pay up. For large institutional investors, a chief source of funds to liquidate and cover their losses is the bonds they also hold. When these institutions are forced to sell their bonds in a market already saturated with Fannie and Freddie trying to sell all they have, you can understand how a bad situation only gets worse.

Are you too late and missed your opportunity?
We are in unprecedented times and no one has a crystal ball and can predict the future. But here is what we know. The fear of a recession is real. With so many people being affected financially by the panic, we are almost certain to have low to negative growth in the next 6 months in the US. That supports the theory that with no underlying inflation, mortgage rates should remain low.

The large glut of mortgage applications will work its way through the system in about 30 days. That means that all the lenders that artificially raised their rates to slow things down will now need to get more competitive again once they get through the backlog.

That is why I believe that if you missed the first round of low rates, you will get a second chance. In order to do so you must be ready to move and move quickly. You should start the application process within the next couple of weeks. Get everything to your lender and have your loan fully processed. When rates come down, they won’t drop suddenly, they’ll come down gradually. You need to have a clear understanding with your loan originator of what your goals are regarding the rate you wish to achieve. But more important, given the uncertainty of the markets, what are you willing to accept to say okay and lock in a rate. In these volatile times rates have been changing multiple times in a single day. It many not be feasible to call you first to get your okay. That is why you need to have a clear understanding with your originator on what rate is eventually acceptable to you.