You know how you see oil prices drop precipitously on the news, yet when you get the gas station to save some money, you’re disappointed because gas prices haven’t gotten much cheaper?
The same thing happens with US Treasury yields (oil) and mortgage interest rates (gas). Mortgage rates are largely influenced by the latest 10-year U.S. Treasury bond yield and will move in the same direction. However, given there are so many different types of mortgages and frictions, mortgage rates won’t necessarily change by the same magnitude.
The coronavirus-induced market meltdown has sent US Treasury bond yields tumbling to all-time lows. But mortgage interest rates are only at ~8-year lows, not all-time lows.
Some Financial Samurai readers are even saying mortgage rates haven’t moved down at all or are actually going up as Treasury yields collapse. If you find yourself in this situation, please keep looking.
So why aren’t mortgage rates going lower as quickly as US Treasury yields? Let me explain.
Why Mortgage Rates Aren’t Falling As Fast As US Treasury Yields
Mortgage rates are not falling as fast as Treasury yields due to one main reason: risk.
It’s not risk, by you, the borrower who can’t wait to refinance their mortgage to save money and improve their monthly cash flow. The risk is felt by INVESTORS of mortgage-backed bonds (MBS), who pay a premium for those bonds and expect to recoup that and more over time, through monthly interest payments from borrowers. Most big lenders package their loans and resell them for income and risk-reduction purposes.
But here’s the thing. As the homeowner paying the mortgage, you will logically want to PAY DOWN your mortgage faster or refinance your mortgage if you see mortgage interest rates drop. As a result, the MBS investor who paid a premium for your mortgage in hopes of earning higher interest payments for a very long time loses because the premium shrinks or the mortgage is refinanced.
Such an investor is like the homeowner who decides to pay points when refinancing their mortgage to get a lower rate, but who ends up selling the home or paying off the mortgage before its breakeven point. This risk of selling your home sooner than expected is why I prefer a “no-cost refinance.”
If you have the time and patience, you should always do a no-cost refinance if the new mortgage rate is lower.
Example Of Why Mortgage Rates Aren’t Dropping As Quickly As Treasury Yields
Long ago, I got a notice in the mail that my Citibank, 30-year fixed mortgage at 4.625% was being sold to some other lender. This was before I developed a strong preference for adjustable rate mortgages.
To make things easier for me to pay the new lender (which is important for the buyer of my mortgage), they gave me instructions on how to cancel my autopay and set up a new one with the new bank. What a pain! But I had to do it because I didn’t want to be late or go into default.
The new lender gave me a 90-day heads up to swap over the autopay, again, to reduce the friction. I spent some time changing my setup and thought I was done with things for a while.
The investor of my loan was expecting to earn a nice 4.625% interest rate from me for ideally the 28 years left on the amortization schedule. I’m sure the borrower paid a slight premium for my mortgage given I never missed a payment, I had a 780 credit score, and a 4.625% interest rate was attractive because mortgage rates were falling.
Only about eight months into paying my new bank, I decided to refinance the mortgage to a 5/1 ARM at 3.375%. The refinance took about three months to complete.
The higher the premium the purchaser paid for my 4.625% mortgage, the more the purchaser lost since it only got my higher interest for about 11 months. I ultimately ended up refinancing the mortgage again after five years at no cost down to 2.875% and then paid the entire mortgage off five years later.
Always Think From The Investor’s Perspective
If you are ever confused about why things are the way they are in finance, always put yourself on the other side of the transaction. Putting yourself in someone else’s shoes not only allows you to negotiate better and invest better, it also allows you to be a more empathetic person during conflict.
When rates fall fast, like they do during a terrorist attack, the start of a war, or a health pandemic, the risk of prepayment increases. As a result, mortgage-backed security investors want to pay a lower premium.
A refinance boom creates underperformance or losses for their existing book of mortgage-backed securities because more of them are getting paid off through refinancing. Therefore, investors are less willing to pay for mortgages.
Key point: As the premium investors are paying goes down, the price for borrowers goes up, slightly, in either up-front costs or higher interest rates. As a result, mortgage rates do not fall as much as Treasury yields.
Final Reason Why Mortgage Rates Don’t Fall As Quickly
Although mortgage rates have fallen to 8-year lows, with the way things are going, I believe there is a ~90% chance mortgage rates across all durations will eventually fall to all-time lows like U.S. Treasury yields.
The reason why I don’t think there’s a 100% chance all mortgage rates fall to all-time lows is because banks, like gas stations make their own bets too. And some banks might just keep their mortgages rates higher on the expectation that Treasury yields will come back up so they can make greater profits.
But if they are wrong, they will probably lose a lot of refinance business to their competitors. Which means they will eventually have to lower their mortgage rates as well. to stay competitive.
Finally, some banks will keep their mortgage rates higher than their competitors simply because they are overrun with business. The lender just doesn’t have enough personnel to handle all the new refinancing demand. Too much demand is partially why my last mortgage refinance took over four months to complete instead of their promised three months.
Just like how it’s difficult to time the bottom of the stock market to purchase, it’s hard to time the bottom of mortgage rates. But unlike with stocks, you know exactly how much money you will save by refinancing a mortgage over a certain period of time once you do the math. You got a bird in the hand.
Everybody with a mortgage needs to be having a conversation with a lender today. If you don’t see rates going lower, keep on hunting for the lender that wants your business. Plenty have the staff and the desire to meet your demand!
Refinance your mortgage: Check out Credible, my favorite mortgage marketplace where prequalified lenders compete for your business. You can get competitive, real quotes in under three minutes for free. Also check out LendingTree to get as any free quotes as possible to make the best decision. Mortgage rates are at all-time lows. Take advantage.
Readers, are you encountering lenders who are stubbornly not dropping their mortgage rates as quickly as the decline in US Treasury bond yields? What type of mortgage rates are you seeing out there with the 10-year bond yield now at ~0.67%?