When there are mortgage market abnormalities, we must take advantage to get the lowest rate and best terms possible.
There are two mortgage abnormalities to be aware of:
1) The average 15-year mortgage rate is way below the average 5/1 ARM rate.
2) The average 30-year mortgage rate has been going down while the 10-year bond yield has been going up.
Don’t Miss Mortgage Abnormalities
With so much euphoria on November 9, 2020 over the great Pfizer vaccine news, it’s worth focusing on the 1%.
I’m not talking about the top 1% income-earners in America. Those folks are doing well, as usual. I’m talking about the 10-year bond yield quickly going back to 1%.
Since August 4, 2020, the 10-year bond yield has been creeping higher. It’s gone from a low of about 0.51% to a high of about 0.85% before the election results. On a percentage change basis, this 67% move higher was massive.
However, during this 67% upward swing in the 10-year bond yield, the average rate on a 30-year fixed mortgage continued to decline to a low of ~2.76% on average. I didn’t write about it at first because I thought it was a temporary glitch in the matrix. However, after more than three months, this abnormality is definitely worth recognizing.
Under normal circumstances, the 30-year fixed mortgage rate should have increased by about 0.25%.
Why Did The 30-YR Fixed Rate Decline When Bond Yields Went Up?
The simple answer is that banks were more able to lend once they got through a tremendous refinance backlog and hired more people.
When the pandemic hit, lending standards tightened tremendously. Refinances took weeks or months longer than normal to close.
For example, it took me a couple weeks longer than average to get pre-approved for a mortgage a month after lockdowns began. Meanwhile, I was getting plenty of feedback from readers that their mortgages were taking longer to close too.
At the same time, demand to refinance skyrocketed given rates fell by over 1% in a short time period. Many lenders found themselves short-staffed and began aggressively trying to hire to meet the increased demand.
To help dampen the volume, lenders also charged a higher spread over an index. For example, instead of charging a mortgage rate 2% above LIBOR, lenders began charging 2.25% or 2.5% above LIBOR.
Banks that found themselves more undermanned than others rationally charged higher mortgage rates. As a result, consumers had to diligently shop around to get the best rate.
Today, lenders have more capacity to handle refinances and purchase loans because demand has subsided and more people are employed to handle the workload.
“Those people who wanted to refinance have already refinanced,” said my mortgage lender. “We’re more focused on purchase loans now,” he continued. As a result, lenders are now charging lower spreads to help boost business once more.
The short lesson from this mortgage market abnormality is that mortgage rates don’t always move closely with the 10-year bond yield. Just because the 10-year bond yield is increasing doesn’t mean mortgage rates are also increasing at the same rate.
Just because the 10-year bond yield has spiked higher post election doesn’t mean there aren’t still some good mortgage deals. For example, you might find a lender who needs to catch up to its peers because it was overly conservative during the first few months of the pandemic.
You see similar market abnormalities when it comes to savings and CD rates as well. Banks that are trying to boost their deposits will entice savers with higher rates. Banks that are flush with deposits will offer pitifully low rates as they focus more on lending. As a borrower, you want to borrow from a bank that is flush with deposits.
The Last Mortgage Market Abnormality
Besides mortgage rates going down when the 10-year was going up, the other mortgage market abnormality is the average 15-year fixed mortgage rate is now much lower than the average 5/1 ARM rate.
Based on data from Freddie Mac, the average 15-year fixed rate mortgage is only 2.32% versus the average 5/1 ARM rate of 2.89% (gap between orange and green line below). I don’t remember ever seeing such a large spread. The most I’ve seen in the past is a 0.25% difference.
Before 2019, a 5/1 ARM (orange line) was often cheaper because the fixed duration was shorter. The time value of money generally dictates that longer duration loans have higher rates (upward-sloping yield curve).
It’s only during times of great distress when the yield curve tends to flatten or invert. However, at the time of this publication, the yield curve has steepened. We’re past the worst of the recession with economic activity and employment strongly bouncing back.
Further, when I locked in a 7/1 ARM earlier in the year, I was able to get 2.625% before my 0.5% relationship pricing discount (net 2.125%). A 15-year fixed rate mortgage wasn’t even a consideration because my lender was quoting a much higher rate.
Why Is The Average 15-Year Mortgage Rate Lower Than The Average 5/1 ARM?
Given we’re still in times of great uncertainty, banks are being more cautious about the amount of money they lend, the duration of each loan, and who they lend money to. Banks are expecting a wave of foreclosures in the future once rent moratoriums end.
From a bank’s perspective, a 15-year fixed rate mortgage is less risky because the bank gets paid back a larger amount each month in a shorter period of time (15 years versus 30 years).
At the same time, borrower demand for 30-year amortizing loans (30-year FRM and ARMs) is higher because borrowers want maximum flexibility and lower monthly payments during times of uncertainty. With higher borrower demand for 30-year amortizing loans, banks can logically charge higher spreads to earn a higher risk-adjust profit.
Therefore, to entice mortgage borrowers to get a 15-year fixed rate mortgage, banks are willing to charge a lower spread and, therefore, a lower mortgage rate.
15-Year Mortgage Over An ARM?
I’ve long been a proponent of getting an ARM over a 30-year fixed rate mortgage for a variety of reasons. However, with the average 15-year fixed rate mortgage so much lower than the average 5/1 ARM, the 15-year fixed rate now looks very enticing.
If you can get a lower mortgage rate and pay down your mortgage quicker, it’s not a bad idea. This is especially true if you like to regularly pay down extra principal anyway.
I’ve never regretted paying down debt, regardless of how much more I could have returned investing the money elsewhere. The process of paying down debt feels great. Having no debt feels even better.
Before you take a 15-year fixed rate mortgage, just make sure you can comfortably afford the higher mortgage payments due to a shorter amortization period. If your all-in homeownership cost is less than 30% of your monthy gross income, you should be good to go.
The Future Of Mortgage Rates
I don’t think the 10-year bond yield and mortgage rates are going to go much higher this winter as virus counts increase. Instead, mortgage rates are likely to stay steady or even head back down once we’re all back under a second lockdown.
However, you just never know where rates will go.
The hit parade of positive vaccine news could cause for risk appetite to increase. Our government might get its act together and pass a new stimulus bill. If so, investors may sell risk-free treasury bonds, causing mortgage rates to go up further.
Goldman Sachs, for example, is incredibly bullish on the future. My old firm has a 3,700 S&P 500 year-end target for 2020 and a 4,300 year-end target for 2021. 4,300 is roughly 20% higher from current levels. JP Morgan has a year-end 2021 S&P 500 price target of 4,500.
If the S&P 500 does rise to such lofty levels, mortgage rates will almost certainly increase. In the short-term, there may also be a slowdown in real estate demand as the cost to own increases.
However, longer-term, a rising mortgage rate scenario likely means your asset values will go up due to stronger overall demand.
If you can break even on a mortgage refinance before you sell your home, you should do so. My general guideline is to refinance if you can break even within 18 months or less. I prefer “no-cost refinances” because you get to break even immediately, even though you’re paying a slightly higher rate.
In terms of when to buy property, I always like hunting for property during the winter. Any property listed close-to or during the holidays generally means the seller is more motivated. Real estate agents like to say that listing during the winter means less competition. However, this is more of the real estate agents’ way of trying to generate more steady business throughout the year.
Check the latest mortgage rates with Credible, my favorite online lending marketplace where qualified lenders compete for your business. Lenders will give you a free, no-obligation rate quote. Also call or e-mail your existing bank and see what they have to offer.
I’m sure we’d all gladly accept higher mortgage rates if our stock portfolios and real estate holdings rise by another 20%. But wouldn’t it be even better to lock in a lower mortgage rate and see our investments increase so much in value as well? Absolutely.
Readers, have you taken advantage of mortgage market anomalies before? Are there any other type of financial abnormalities you’ve exploited? The 15-year fixed mortgage’s huge rate discount to the 5/1 ARM is something I’ll be exploring more in the future.