Your bank won’t give you a mortgage rate in the 2’s. Here’s why

Peter Miller
Peter Miller
The Mortgage Reports Contributor
March 2, 2020 - 8 min read

Mortgage lenders don’t want rates to keep falling

Mortgage rates should be much lower. Probably in the 2’s.

But in many cases, banks and end investors won’t let rates drop much further.

Lenders are already experiencing expensive “lock fallout.” That’s when borrowers bail on their locked loan applications to seek lower rates elsewhere.

And investing groups aren’t exactly excited about ultra-low returns and paltry mortgage interest.

Here’s why rates aren’t falling as fast as they should be.

Date Range 10-Year Treasury Maturity Rate Average 30-Year Mortgage Rate Difference
February 2017 2.42% 4.17% 1.75%
August 2017 2.19% 3.88% 1.69%
February 2018 2.86% 4.33% 1.47%
August 2018 2.89% 4.55% 1.66%
February 2019 2.68% 4.37% 1.69%
August 2019 1.63% 3.62% 1.99%
February 28, 2020 1.16% 3.45% 2.29%

Source: Federal Reserve Bank of St. Louis, Freddie Mac

In theory, the rate difference between the 10-year Treasury and 30-year fixed mortgage rate should be consistent over time.

The difference between the two rates has averaged around 1.7% over the past three years. If history is our guide, rates should be much lower.

If mortgage rates were moving with the 10-year Treasury as usual, they should be just 2.85% right now.

The closing rate of the 10-year on Friday, February 28 was just 1.156%, a new all-time low. If you add 1.7%, you get 2.85%.

Yes, the 30-year fixed-rate mortgage should be just 2.85% right now.

But Freddie Mac reported an average rate of 3.45% as of February 27. What gives?

>> Related: Streamline refinance — get today’s rates with almost no paperwork

Why mortgage rates aren’t lower

Mortgage rates don’t always follow trends like we wish they would. And the more unexpected the circumstances are, the less predictably rates move.

As for today’s mortgage rates, there are a few things going on:

Mortgage rates are not based on Treasuries

Mortgage rates usually don’t drop as fast as 10-year Treasury rates.

Another financial instrument, mortgage backed securities (MBS) control the ups and downs of interest rates for mortgages. And MBS have to answer to end investors, namely investing groups that collect interest on those mortgages.

In many cases, investors just can’t accept an ultra-low return on their investment. Mortgage rates must go higher to keep end investors happy.

Lenders keep rates artificially high

If lenders let rates drop too far too fast, their existing clients who have locked will bail on their applications and re-apply with another lender.

“Lock fallout,” as it’s known within the industry, is expensive for lenders. So lenders keep rates artificially high to keep clients invested in their loan process.

Additionally, many lenders aren’t equipped to take on huge volumes of mortgage applications. Volumes would increase to unsustainable levels if a lender dropped its 30-year fixed to around 2.85% — where rates should be.

Mortgages are worth "less" when rates fall

Remember those mortgage investors? Well, they know today’s mortgage borrowers are tomorrow’s mortgage refinancers. That is, if rates fall too far, too fast.

Investors only make money if they can collect interest on the mortgage long-term. They don’t like it when you pay off your mortgage, either with cash or a refinance.

So a falling interest rate environment works against itself, pushing rate levels up from the bottom (from banks and investors), even as the larger environment is trying to push rates down.

A look at mortgage rate movements in the past few weeks

Mortgage rates have fallen to new lows as the carnage on Wall Street continues.

Will real estate financing get cheaper and cheaper or have we hit bottom? These are huge questions for those who want to finance and refinance real estate – as well as those with homes to sell.

Mortgage rates have declined substantially during the past year or so.

Mortgage rates averaged 4.87% in November 2018 according to Freddie Mac.

This week, says the company, the typical mortgage rate is 3.45% for 30-year fixed-rate financing.

Fifteen-year mortgages cracked the 3-percent barrier. They’re down to just 2.95%.

These numbers have real meaning.

Borrow $200,000 at 4.87% over 30-years and the monthly cost for principal and interest is $1,050. Lower the rate to 3.45% and the monthly cost falls to $890.

That’s a savings of $165 per month or nearly $2,000 per year.

Put differently, it’s like living mortgage-free two months per year when compared with the November 2018 rate.

Falling mortgage rates and home buying

“Low mortgage rates have brought buyers back to the housing market, but a lack of listings means buyers are having to compete with one another to secure a sale and lock in a mortgage rate,” said Redfin chief economist Daryl Fairweather.

“This competition pushes up prices, which means that even though buyers can get a good deal on a mortgage now they are often paying a higher sticker price.”

Does this mean real estate bargains are not available?

The National Association of Realtors says existing home prices in January were 6.8% higher than a year earlier.

That means a home that cost $200,000 in January 2019 is likely priced at $213,600 at the start of this year.

And what about mortgage rates?

It’s not an exact comparison, but consider this: In November 2018 a $1,050 monthly payment could get you a $200,000 mortgage. Today that same payment allows you to borrow $237,000.

The bottom line? Both home prices and affordability have increased in many markets. It’s a win for sellers, and a win for buyers.

Today’s mortgage rates and refinancing

Today’s new mortgage rates mean that borrowers with existing mortgages should take a look at their current financing.

When property owners refinance they should require a material benefit such as:

  • A lower rate
  • A smaller monthly cost for principal and interest
  • A smaller lifetime interest cost
  • A switch from adjustable rates to fixed rates
  • Refinancing costs that can be repaid through loan savings in three years or less

The rapid and substantial mortgage rate decline seen in the past year or so means that refinancing can produce real benefits for many borrowers.

For details and a look at the numbers, check in with a few lenders to get custom mortgage quotes.

Will borrowers rush to prepay loans?

In a market with falling rates, it follows that many borrowers will want to refinance.

That’s bad for investors because they will lose an asset with a given rate of return in a market where they can only get less by re-investing.

It’s good for borrowers because they can lower their monthly payments and even pay off a big chunk of their mortgage if housing costs suddenly become more affordable.

Since most mortgages today lack a prepayment penalty, borrowers have a lot of freedom to finance and refinance.

While lenders may be unhappy with your decision to refinance you have to do what’s best for you — just like lenders.

The impact of Wuhan coronavirus (COVID-19) on mortgage rates

There is no question that the coronavirus has impacted both Wall Street and the mortgage marketplace. There are winners and losers.

On one side share values are going down. That’s bad news for many stock investors.

On the other side mortgage rates are falling. That’s good news for real estate borrowers and borrowers in general.

Could coronavirus force a U.S. recession?

The coronavirus will be blamed if the country slips into recession. A slowing US economy will mean a lower GDP for at least two quarters as well as increased unemployment.

The current expansion — which dates from June 2009 — is the longest on record. As of January, existing home prices had enjoyed 95 straight months of year-over-year gains according to the National Association of Realtors.

The reality is that economies go up and down. We are long overdue for a slowdown if not an outright recession.

A widespread coronavirus outbreak would be just one more factor contributing to a slower economy.

Mortgage rates versus 10-year Treasury notes

It’s long been an article of faith that mortgage rates and 10-year Treasury notes pretty much move in tandem.

That’s because investors worldwide see mortgages and 10-year notes as similar in terms of risk and reward.

This relationship leads to the notion that mortgage rates “can’t” drop as fast as 10-year treasuries.

Why? Because mortgage rates are based on mortgage-backed securities, which it’s argued aren’t in lock-step with treasuries.

There are two takeaways for borrowers here:

First, 10-year Treasury notes are important to watch because they’re a quick and handy way to see which way mortgage rates are generally moving.

For instance, yesterday, February 27th, 10-year Treasury dropped to 1.27%. According to CNBC, “10-year Treasury bond yields have fallen to levels last seen in 1945.”

Second, should you lock-in today’s rate or let it float until closing?

If you think rates will go lower then float. If you think rates are pretty much where they will be in a few weeks or might go higher then lock.

Will lenders continue to reign in mortgage rates?

You may have noticed that gas prices seem to rise rapidly but fall slowly.

Does the same apply to mortgage financing? Might lenders try to slow the fall of rates to ride out a higher profit margin?

It might happen. Lenders have the right to price mortgage financing as they want.

The best defense for borrowers is to shop around, let lenders compete, and look for the price and terms which work best for you.

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