Could today's mortgage rates fall to the 2s?
A confluence of rate-friendly factors could soon take mortgage rates to their lowest levels of all-time; below the lows of early this year and well-south of the all-time lows reached in May 2013.
30-year conventional mortgage rates are now near 3.75 percent. By October of this year, though, they could be an entire percentage point lower.
Mortgage rates in the 2s would increase today's home buyer's purchasing power by more than ten percent, and would make the decision to refinance a home an absolute no-brainer.
Mortgage rates for FHA and VA home loans would be even lower.
Scoff not. There are multiple scenarios in which mortgage rates could drop below 3.00%. Furthermore, it could happen sooner than you think.
When banks quote mortgage rates to consumers, rates are based on the real-time prices of mortgage-backed securities (MBS).
Mortgage-backed securities are a specific bond type, bought and sold by investors on Wall Street and globally. Investors holding mortgage-backed securities, which are also known as mortgage-backed bonds, receive regular payouts on their bond holdings from the issuing entities.
The three largest issuers of MBS are Fannie Mae, Freddie Mac, and Ginnie Mae.
A mortgage-backed security is exactly what its name suggests -- it's a security which is backed by mortgages. There are often hundreds of mortgages pooled into a single MBS issuance and, because Fannie Mae, Freddie Mac, and Ginnie Mae are U.S. government-backed entities, mortgage-backed bonds are considered to be extremely safe in which to invest.
Conventional mortgages are pooled through either Fannie Mae or Freddie Mac; and, FHA, VA and USDA loans are pooled via Ginnie Mae.
Because of this pooling separation, mortgage rates for FHA, VA, and USDA loans are often cheaper than rates for conventional loans. FHA, VA, and USDA loans are specifically insured or guaranteed by the government explicitly. Conventional mortgages are not and, therefore, are slightly more risky in which to invest.
Investors demand higher returns for higher risks, which is why conventional mortgage rates are sometimes 40 basis points (0.40%) higher than rates for a comparable VA loan.
For all MBS types, bond prices affect bond yields, which are what "set" current mortgage rates. The Federal Reserve doesn't set rates and neither does your bank pull a rate from thin air.
When bond prices change, bond yields change, and this is what affects rates.
Bond prices and yields move in opposite directions so when bond prices rise, mortgage rates drop; and, vice verse.
Today, mortgage rates are firmly in the 3s. Before long, rates could drop to the 2s.
According to Freddie Mac's weekly mortgage rate survey of more than 100 U.S. lenders, the 30-year conventional, fixed-rate mortgage has lived under four percent for prime borrowers for 21 straight weeks, dating back to November of last year.
It's been 216 weeks since mortgage rates wore a five-handle, and this decade has not seen a mortgage rate in the 6 percents ever.
Truly, we're living through an historically inexpensive period for mortgage rates.
Even better, though, is that rates could go lower. With today's mortgage rates firmly in the threes, buyers and refinancing households should plan for the possibility that mortgage rates will reach into the 2s before the year's out.
There are three forces currently working in your favor. Each is expected to push MBS yields down, which results in lower mortgage rates. Put all three together, and you have a recipe for the lowest mortgage rates of a lifetime.
The first reason mortgage rates will drop is that the U.S. is one of the few remaining global markets in which investors can purchasing decently-yielding, investment-grade, government-backed debt.
Currently, the benchmark 10-Year U.S. Treasury Note yields near 1.90%. Comparatively, Germany's 10-Year bond yields 0.07% and the bond yields for France, Canada, and Japan are 0.35%, 1.41%, and 0.22%, respectively.
Meanwhile, in Switzerland, the 10-Year Bond yields negative 21 basis points (-0.21%), which means that investors pay the Swiss government for the right to park their cash.
There are other nations in which investors can invest to earn a positive return -- Australia and South Korea, as examples -- but the U.S. offers a strong combination of low risk with (relatively) high yield.
So long as global economies sputter through 2015 and into 2016, demand for U.S.-backed bond issuances should increase, including the demand for mortgage-backed bonds which are implicitly (Fannie Mae and Freddie Mac) and explicitly (FHA, VA, and USDA) guaranteed by the United States government.
As MBS demand rises, bond yields fall and mortgage rates drop.
The Federal Reserve does not control mortgage rates, but it can exert an influence over them. Later this year, expect that force to be strong.
The Federal Reserve is the nation's central banker and its dual-charter is to maximize employment rates while keeping inflation rates in check.
To the Fed, this means getting the Unemployment Rate near 5.5 percent nationwide, which is the rate at which the Bureau of Labor Statistics reported unemployment for March 2015; and, holding annual inflation rates near 2 percent.
Inflation is the rate at which the U.S. dollar loses value over time. When inflation runs at two percent annually, it means that consumers require 2% more dollars in order to purchase the same amount of goods or services as compared to the year prior.
Since December 2008, when the Fed first voted to put the Fed Funds Rate in a target range near zero percent, inflation rates have remained low; nearer to one percent than 2%.
Meanwhile, the Fed's zero-interest rate policy (ZIRP) promotes economic growth by reducing business and consumer costs and it can take years for Fed policy to work its way through the economy. This is why the Fed is watching employment data closely -- especially wage growth.
There's such a thing called the Wage/Price Spiral in which wages rise for employees, then prices rise as business owners try to remain profitable. This, in turn, results in demands for higher wages and the cycle continues.
The Wage/Price Spiral is inflationary so with employment rates rising nationwide, the likelihood of consumer prices rising, too, is high.
The Fed is watching this closely and, regardless how the broader economy is performing, the group may move to raise the Fed Funds Rate in advance of a measured rise in inflation just to get ahead of what's next.
So, if inflation devalues the U.S. dollar, slowing inflation's pace will help the dollar to hold its power high, which is great news for the future of mortgage interest rates.
It's all because mortgage-backed securities are denominated in U.S. dollars.
When the dollar loses value because of inflation, demand for MBS drops and bond yields rise. However, the reverse is true, too.
As the dollar's value grows, the value of holding mortgage-backed bonds issued by Fannie Mae, Freddie Mac, or Ginnie Mae increases, and investors tend to invest where they can earn a better yield.
For consumers, a Fed Funds Rate hike could mean lower mortgage rates nationwide.
As investors chase higher yields and the Federal Reserve votes to raise the Fed Funds Rate, it will expose an issue which, to date, has gone largely unnoticed -- there are too few MBS issuances to satisfy everyone who wants to hold them.
MBS scarcity will be the third factor in driving mortgage rates to the 2s.
Since 2010, mortgage guidelines have gradually loosened and, today, it's easier to get loan than during any period in the last decade. Minimum credit score requirements have dropped and maximum loan-to-value ratios have climbed.
Ellie Mae reports more loans getting through underwriting than during any time in the last five years. Yet, overall MBS issuance from Fannie Mae, Freddie Mae, and Ginnie Mae is down by more than 68 percent over the same period of time.
There are fewer home buyers entering today's market; and homeowners are opting to not refinance, despite the monstrous monthly savings available.
For these reasons, in 2014, Fannie Mae, Freddie Mac, and Ginnie Mae issuance the fewest mortgage-backed securities in 18 years. Yet, mortgage-backed bonds are increasing a part of large, safe, balanced portfolios.
Consider that the average daily trading volume in federally-issued MBS reached its highest point in more than a year this past January. That happened without Fed intervention and without QE3.
Demand for MBS is high because the U.S. economy is healthy, home prices are rising, and because strong job growth portends well for the ability of U.S. homeowners to make good on their home loan payments.
In other words, the risk of owning mortgage-backed bonds has dropped, which has helping to stoke demand. That demand is expected to increase as global yields fall and inflation rates drop.
The downward pressure on current mortgage rates is palpable and will continue to push interest rates down, overall, through the summer months and into fall.
Before long, two-percent rates could arrive.
Since 2009, mortgage market forces have pressured interest rates lower.
Rates have dropped from 6 percent into the threes; and there's a good case to be made that today's home buyers and refinancing households will soon have access to rates on a two-handle.
However, two "artificial" forces may keep rates from reaching their destined lows -- (1) lenders, and (2) the government. Both can play a middle-man role keeps U.S. consumers from getting access to the lowest mortgage rates possible.
One of the biggest threats to low mortgage rates, paradoxically, is low rates itself. This is because when mortgage rates drop, refinance volume spikes, and there comes a point where lenders just can't keep up.
In response, they raise rates.
We've seen this happen a number of times in the past decade, including the first-half of 2013 when conventional mortgage rates slipped below 3.50 percent.
Refinance volume surged and lenders were overwhelmed. Conventional wisdom held that mortgage rates should have moved to 3.25% or lower. However, it never happened -- lenders were holding rates high to slow the flow of incoming loans.
See, for all of the advances in mortgage technology this decade; for all of the improvements in the mortgage underwriting and approval process; and, for all the automation introduced, the mortgage industry remains resource-intensive.
It takes a certain number of people to move a loan from its opening to its closing and, in the mortgage industry, there are far fewer people working loans as compared to the last ten years.
According to MortgageDaily.com, the mortgage industry has shed 192,000 jobs since 2006, which represents a one-quarter reduction in workforce. 28,000 jobs were lost in 2014 and there are currently just 578,000 people in today's mortgage industry.
Meanwhile, loan volume is increasing.
In the first quarter of 2015, as mortgage rates dropped to the 3s, there were more refinance closings than during any period since 2013; and purchase loans are surging, too.
Nationwide, lenders are close to reaching capacity and a just small drop in rates could trigger rate hikes meant to slow new business intake.
The farther mortgage rates drop, the bigger this risk becomes.
A second risk to low mortgage rates is what the government refers to as Loan-Level Pricing Adjustments (LLPA). LLPAs are fees which are added to the cost of a loan for specific traits, which add to the overall risk of a loan.
For this reason, LLPAs are sometimes known as "risk-based fees".
Some examples of traits which add to the risk of a loan include loans made for homes with 2-4 units; loans made to borrowers with credit scores below 740; and, loans which are of the "cash out refinance" variety.
Loan-level pricing adjustments are managed by the Federal Housing Finance Agency (FHFA) and apply to conventional loans only.
They were first introduced in April 2008 as a way for the government to collect additional fees from "risky" borrowers without penalizing "safer" ones. It's a similar system to how auto insurance works -- the riskier your driving habits, the higher your costs.
LLPAs can be paid in either of two ways -- as discount points, or "built-in" to the rate. Most banks do the latter, by default, because the cost of a loan-level pricing adjustment can be as much as three percent of your loan size.
For example, if you're buying an 2-unit investment property with 25% down and your credit score is 720, your LLPA totals 3.25%, which equate to a one-time closing cost of $3,250 for every $100,00 borrowed.
Banks know that such costs can be off-putting, though, so most will embed the costs into your mortgage rate directly with each percentage point of LLPAs increasing your mortgage rate approximately 25 basis points (0.25%).
With current mortgage rates at 3.00%, buying that 2-unit investment property with a 720 FICO will raise your rate to near 4.00%.
Since the first LLPA pricing chart was introduced, it's been modified more than a half-dozen times. The next adjustment is slated to take effect September 1, 2015.
With the next iteration, borrowers making low downpayments will be hit with higher costs; as will borrowers whom are buying investment properties. With the government serving a middle-man, rates will be inflated.
Furthermore, there is nothing to stop the government from adding larger loan-level pricing adjustments later this year to help the Federal Housing Finance Agency grow and stay profitable. When market rates drop, accepting new, built-in fees can be more palatable for consumers.
By contrast, the removal of today's existing LLPAs could help rates get to 2% sooner.
Today's mortgage rates are near their lowest of all-time and, before long, conventional rates could touch the 2s. FHA and VA mortgage rates may get there even sooner. You may not want to sleep on it, though. Mortgage rates and markets change often, and can change for the worse.
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2016 Conforming, FHA, & VA Loan Limits
Mortgage loan limits for every U.S. county, as published by Fannie Mae & Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA)