Are Banks Holding Today’s Mortgage Rates Artificially High?

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Mortgage rates are ultra-low these days, but they ought to be lower. Lenders may be holding rates artificially high.

How Mortgage Rates Are Made

Mortgage rates are made from thin air. Rather, the mortgage rates you see online and advertised by banks are based on the price of a specific bond-type known as a mortgage-backed security.

Mortgage rates are not based on the 10-Year Treasury Note. If they were, the chart at right would be flat. The 10-Year Treasury is a U.S. Treasury-backed bond, with a 10-year term.

Mortgage-backed securities, by contrast, are something else. They are securities backed by mortgages.

MBS pricing works just like stocks. When bonds are in demand, bond prices rise. When bond demand is low, bond prices fall.

Bond "rates" move opposite of prices. When prices rise, interest rates drop. Bonds in the highest demand, therefore, offer the lowest rates of return.

Bond demand fluctuates from minute-to-minute based on factors such as inflation expectations, economic developments, geopolitical events, and computer-based/algorithmic trading.

Mortgage pricing, therefore, changes minute-to-minute, too.

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Banks Are Your Middleman To Wall Street

As consumers, people like us can't get "raw access" to mortgage bond pricing. To get a mortgage rate, we have to work through third-party middlemen known as a conduits.

Conduits are often "the bank", and even when a bank touts itself as selling "direct to Fannie Mae", it's still a conduit.

As middlemen, conduits set two important numbers :

1. The profit margin to be earned by the bank
2. The mortgage rate to the charged to the borrower

These two figures are related. Banks charge specific mortgage rates to keep their profit margins in-line. They also use mortgage rates as a way to speed up or slow down new business.

This is an increasingly important to rate shoppers with the introduction of the new HARP program, and with mortgage rates still near 4 percent.

Low rates can't last forever.

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It's Not Collusion, It's Confusion

Over the past half-decade, mortgage lending has been in transformation. Loans have gone bad, lenders have booked losses, and the housing market has slumped. Banks have responded by "getting lean", reducing sales teams and back-office operations.

The number of people working in mortgages in 2011 is  less than half of what it was in 2006, and banks aren't done with the layoffs. More people will be let go in 2012 on the expectation of lower loan volume ahead.

The problem, though, is that a  combination of falling mortgage rates and government-led stimulus program (such as the new HARP program) is holding loan demand high.

Banks don't have the capacity to handle new business so they're slowing their inbound business the only way they can -- by raising mortgage rates.

When a bank has higher mortgage rates as compared to its peers, it will earn less business; mortgage shoppers are savvy. The problem is the raising rates can be contagious. When one bank does it, the others sometimes follow.

This is one reason why mortgage rates were sub-4 percent for only a few hours this month. There was an influx of new loans that forced some lenders to put on the brakes.

Why Mortgage Rates Can't Rest Under 4%

There's a bizarre cause-effect relationship in lending right now.

1. When market forces lead mortgage rates to drop, loan demand rises.
2. When loan demand rises, lender capacity issues lead mortgage rates to rise.

This is why low rates can't last long, and why government stimulus creates just a mini-window in which to lock a low rate. As soon as rates drop, lender pipelines max out. Inevitably, banks raise rates.

You can capitalize on low rates -- you just have to jump in faster than your neighbor.

Why Rates Should Rise Next Month

Mortgage rates remain low, but are poised to rise in the coming weeks. The first reason is the low rates beget high rates, as we've seen. The second reason is that the Federal Reserve is meeting next week and some analysts expect the Fed to expand its mortgage bond stimulus program.

If it does, mortgage rates should drop on better MBS pricing, Before long, though, the conduits will take over and mortgage rates should rise.

Your "safe" play is to lock a mortgage rate now.

Click here to get a rate quote.