When there are mortgage market abnormalities, we must take advantage to get the lowest rate and best terms possible.
There were two mortgage abnormalities to learn from in 2021. This case study can help us take advantage of future mortgage market abnormalities so we can get the best rates possible.
1) The average 15-year mortgage rate was way below the average 5/1 ARM and 7/1 AM rate. Therefore, you should take advantage.
2) The average 30-year mortgage rate has been lagging behind while the 10-year bond yield has been going up. Therefore, the 30-year fixed rate mortgage looks very enticing as well.
As a result, if you are looking to refinance your mortgage or are buying a house, get either a 30-year fixed or a 15-year fixed. Both are offering the best value out of all the mortgage products that current exist today.
Credible is my favorite place to refinance a mortgage or get a new mortgage. You'll get real, no-obligation quotes from competing lenders in minutes. Take advantage of the current mortgage market abnormality!
Don't Miss Mortgage Abnormalities
With so much euphoria over the opening up of the economy, 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%+ and now at ~1.55%. Inflation exceptions are much higher now due to great anticipation of economic growth.
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 presidential 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%. Today, the 10-year bond yield has rise by about 1.15% (1.65% – 0.5%). However, the 30-year fixed rate mortgage average has only increased by 0.45% on average. This mortgage anomaly is an opportunity!
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.
Lenders Increased Their Spread
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.
Mortgage Lesson To Learn
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. Well-qualified borrowers are actually getting much lower mortgage rates than the reported averages.
Also, 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 the latest data from Freddie Mac, the average 15-year fixed rate mortgage is only 2.15% versus the average 5/1 ARM rate of 2.44%. I don't remember ever seeing such a large spread. The most I've seen in the past is a 0.25% difference. Take advantage!
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
We are in a goldilocks situation with rising stock prices, higher rates that are still historically low, and rising real estate prices. Further, the FHFA increased the conforming loan limits in 2022 by 18%.
However, today's mortgage abnormality is that the yield curve is inverted. As a result, some commercial real estate developers and sponsors are struggling because most of their loans are variable.
To take advantage of this dislocation, Fundrise launched the Opportunistic Credit Fund. If you can't invest in the Opportunistic Credit Fund, then you can invest just $10 minimum in its Real Estate Income Fund.
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.
Invest In Real Estate More Strategically
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I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$380,000.