Mortgage interest rates are at record lows and will keep falling in the near future. August 6 saw a drop in mortgage interest rates to under 3 % giving buyers a huge incentive to purchase a new home.
According to forbes.com, the spread between 30-year fixed-rate mortgages and the yield on 10-year treasury bonds is still “above longterm norms.” The spread usually runs between 1.5 and 2.0 percentage points but as of August 6, the spread was up to 2.33 percentage points. In order to predict how much lower mortgage rates will fall, the crucial question as to why the spread rose above 2.0 needs to be answered.
To understand spread the whole process needs to be explained. The majority of mortgages derive from a bank or mortgage company. The bank or mortgage company then turns around and sells the mortgage to a federal agency such as Fannie Mae or Freddie Mac. The federal agency then will promise full repayment of the loan. They take all loans acquired and bundle them into securities that are then sold to investors.
Basically, a bank or mortgage company that created the loan will then resell it one of the agencies and pocket the spread. When the rates dropped the market was flooded with consumers who wanted to refinance. The mortgage originators could not handle the vast amount of applicants. “The mortgage originators had trouble scaling up.”
In today’s market mortgage originators are taking some huge risk. When reselling mortgages there is a greater chance something goes wrong in between creating the loan and reselling the loan to an agency. Rates are also rapidly changing, so mortgage originators are having a harder time keeping the rate commitment to a borrower. With all of the volume, the mortgage process is taking longer which means a higher risk. In order to compensate for these higher-risk, originators have bumped up their spreads.
Currently, the volume of refinances is up 84% from this time last year. According to Mortgage Bankers Association report, the market was not able to digest this vast amount causing investors to pause on buying the securities. When this occurred, the interest rates on wholesale bundles rose significantly.
Black Knight recently reported, “As of July 23, with the 30-year rate at 3.01%, there were still 15.6M refinance candidates that met broad-based underwriting criteria, which included being current on their mortgage, having a credit score of 720 or higher, and having at least 20% equity in their homes. These refinance candidates could also reduce their 30-year interest rate by at least 0.75% through a refinance, with an average savings of $289 per month and an aggregate savings of more than $4.5B per month if each of those homeowners were to refinance their mortgage.”
As mentioned earlier, the spread between 30-year fixed-rate mortgages and 10-year treasuries is currently 2.33. The spread should drop to at least 2.00 according to forbes.com. The mortgage rates should drop gradually in the following weeks.
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