Last Sunday the Federal Reserve announced they were cutting “Rates” to zero. Unfortunately, often borrowers assume that means mortgage interest rates will also go down. Many lenders have had borrowers calling saying that they heard “Rates” are at zero. This is unfortunate and causes lots of confusion for borrowers. The media reporting adds to the confusion.
Let’s start here. The Federal Reserve controls the Federal Funds Rate. This is the rate that applies to overnight loans (1 day) between the largest financial institutions in the U.S. The Federal Reserve does not dictate mortgage interest rates and their rate setting does not directly affect any mortgage rates except for home equity lines of credit.
At times, the Federal Funds rate and mortgage rates move in the same general direction and at times (like now) they do not. However, they are fundamentally different types of loans since one is for one day and the other is most often for 30 years. Lenders and investors have different priorities for a one-day loan versus a 30-year mortgage.
HOW ARE MORTGAGE RATES DETERMINED?
There is a market where mortgages are traded daily. The participants are institutional investors and financial professionals. It is called the Mortgage Backed Securities market and what is traded are mortgage bonds. This market is like the stock market and there are thousands of trades a day that involve mortgage bonds.
The prices of mortgage bonds are determined by the buyers and sellers. When buyers have better investment alternatives, they will demand lower prices in order to invest in mortgage bonds, which results in the investor receiving a higher interest rate for their investment. When the investor receives a higher rate to purchase mortgage bonds, that means mortgage interest rates to the consumer will go up. Conversely, when investors are looking for less risky and more predictable assets the demand for mortgage bonds will increase and the price/interest rate offered will go down since there are many buyers and mortgage bonds are in high demand. When the investor receives a lower rate to purchase mortgage bonds, that means mortgage interest rates to the borrower decrease.
Because mortgage bonds trade on a daily basis, mortgage interest rates can and do change on a daily basis (sometimes many times a day). By contrast, (except in emergencies) the Federal Reserve meets 8 times a year and may or may not adjust the Federal Funds rate.
Additionally, mortgage interest rates can be influenced by the broader bond market. The 1-year, 10-year and 30-year Treasury bonds often move in the same direction. However, what is generally true is not always true since the treasury bond market tends to be more stable in times of stress. Additionally, there are other factors that also influence the mortgage bond market that could cause mortgage interest rates to be disconnected from the treasury bond market.
WHERE ARE WE NOW
By some accounts the last two weeks have been the most volatile in the history of the mortgage bond market. Seven or eight days ago, 30-year mortgage rates for the most credit-worthy borrowers were in the low 3% range. The past week closed with the lowest rates being offered at close to 4%. Don’t believe the advertisements on the internet and on the radio. The mortgage bond market has been very fluid and has been very volatile, so getting accurate pricing is not possible when rates are changing 5 or 6 times a day. The internet and radio ads cannot keep up.
Unlike 2008, which was the last time the mortgage markets were this chaotic, the reasons for the volatility have nothing to do with the banking or mortgage industries. First, the reaction to the Coronavirus has created an unprecedented situation and general uncertainty for the economy, at least in the short term. When there is uncertainty, investors want liquidity (cash), which means they sell their assets. In the past two weeks, investors have been selling all asset classes, which includes stocks, treasuries, corporate bonds, and mortgage bonds. The selling of these assets results in mortgage bond prices going down, which increases the mortgage interest rate to consumers.
The other factor weighing on the mortgage bond market is the fact that prior to the current situation, a large volume of mortgage bonds was issued in the first 2 months of 2020 due to the volume of refinancing that has taken place as interest rates declined. There simply are not enough buyers for all the new mortgage debt generated in the past two months. The problem is now amplified by investors wanting to hold cash. This depresses the price of mortgage bonds and causes mortgage interest rates to the consumer to rise.
To summarize, mortgage interest rates are not currently at zero and will never be at zero since no investor would ever invest in a mortgage bond with an interest rate of zero.
While mortgage interest rates have increased over the past 7 or 8 days, there is strong belief when things calm down, that mortgage interest rates will back closer to where they had been. There is no way to know if they will get as low or what the time frame for that is.
I am advising my clients that if they are looking to refinance at a certain rate and we are above that rate then we should get prepared and have everything ready to go so that when rates fall to their desired level that we can be opportunistic and lock right away. Often when rates fall, they may only stay low for a few hours or a few days.