Curve

The race to zero: How mortgage rates got left behind

Craig Berry
The Mortgage Reports contributor

Why aren’t mortgage rates lower?

In an unprecedented move, for the second time in two weeks, the Federal Reserve held an emergency meeting Sunday night where it announced it would slash rates — again.

It was the largest emergency rate reduction in the Fed’s more than 100-year history.

Additionally, the Fed said it would buy billions in Treasury securities and mortgage-backed securities.

In a normal world, both these moves might help to push mortgage rates down. But at the moment, rates seem stuck near 4 percent.

What’s going on here? And what should you expect in the coming weeks?

What happened at the Federal Reserve emergency meeting

The Federal Reserve announced on Sunday it would drop target interest rates to zero, and buy at least $700 billion in government and mortgage-related bonds.

This was part of a wide-ranging emergency action to protect the economy from the impact of COVID-19.

These moves by the Fed are the most radical by the U.S. central bank since the 2008 financial crisis.

These moves by the Fed are the most radical by the U.S. central bank since the 2008 financial crisis.

In an attempt to keep financial markets stable, and make borrowing costs as low as possible for businesses and consumers, the Federal Reserve cut its benchmark rate to a 5-year low.

This put the target fed funds rate at 0%-0.25%.

In addition to cutting interest rates, the Fed announced it is restarting the crisis-era program of bond purchases known as “quantitative easing.”

That’s when the Federal Reserve directly purchases securities, including mortgage-backed securities. In theory, this should push interest rates down for borrowers.

But the mortgage industry might not respond to these measures as quickly as borrowers would hope.

Where’s my zero percent interest rate?

Yes, the Fed cut interest rates to zero on Sunday.

But, that doesn’t mean you should be expecting to see mortgage rates at zero anytime soon.

Here’s why.

First, the Federal Reserve slashed the fed funds rate; not mortgage rates.

The fed funds rate is the rate at which banks and other financial institutions lend money to one another.

It directly affects some rates for borrowers, like home equity loans and credit cards. But the fed funds rate is not directly tied to mortgage rates.  

>> Related: How mortgage rates connect to the fed funds rate

Rates will sometimes drop following a rate cut by the Federal Reserve. However, there are times when mortgage rates actually rise following a rate cut.

This is something many homeowners have experienced in the past couple of weeks.

Mortgage rates operate in their own market, independent of the Fed

Initially, the Federal Reserve cut rates down to one percent, and mortgage rates hit historic lows. But, practically overnight, rates shot up.

The reason? Too many mortgage applications and not enough liquidity in the secondary market that buys securities backed by mortgages.

>> Related: Record-low mortgage rates skyrocket due to strange lending phenomenon

According to Jeff Tucker, economist at Zillow, “It’s classic supply and demand. Lenders were overwhelmed by the demand. They’re having trouble taking more applications.”

“It’s classic supply and demand. Lenders were overwhelmed by the demand. They’re having trouble taking more applications.” — Jeff Tucker, Economist, Zillow

When demand is strong, lenders can be reluctant to lower prices and crimp their profits, especially if their competitors don’t.

Supply must also be considered from the lender’s standpoint. Even in cases where lenders still had money to lend, the record surge in refinance demand forced them to raise rates simply to slow the flow of new business.

Other reasons rates aren’t as low as they should be

Treasury yields have been hitting record lows as investors worried about the impact of the coronavirus pile into safe-haven government bonds.

When setting mortgage rates, lenders typically use the 10-year Treasury yield as a guide.

This has caused plenty of confusion this week. Many savvy consumers were waiting for mortgages to drop as much as Treasury yields did. 

If history is our guide, mortgage rates should be around 1.7% higher than the 10-year Treasury yield. That means rates would be around 2.8% right now.

Instead, mortgage rates jumped at break-neck speed.

Mortgage rates are typically around 1.7% higher than the 10-year Treasury yield. That means rates should be around 2.8% right now.

Why? Mortgage rates don’t always move in tandem with Treasury yields. There are certain roadblocks that can keep rates from falling quickly, or falling at all.

Lenders often sell the mortgages they expect to make to investors, which can make is difficult to lower rates.

When borrowers take out a mortgage, they can often get a “rate lock” where the lender guarantees a certain rate if they close the loan within a set period, no matter what happens to rates in the open market.

But when rates fall as quickly as they have, borrowers often try to renegotiate the rate they locked in.

Falling rates can create a disconnect between what the lender offered to the borrower and what it offered to the investor, and has made some lenders hesitant to lower their rates.

This can create a disconnect between what the lender offered to the borrower and what it offered to the investor, and has made some lenders hesitant to lower their rates.

Mortgage lenders also face pressure to hedge with interest rates, since bond yields could increase from the time when a borrower locks in a rate until when they close the loan. This would make it harder to sell the loan on the secondary market.

What to expect in the coming weeks

Much like the stock market, mortgage rates have been on a wild ride in recent weeks. And, the ride may not be over yet.

Lower interest rates encourage more money into the economy, inducing businesses to invest and consumers to spend and borrow. This helps keep money flowing through the economy. 

These actions normally serve to calm investors.

Clearly, based on the stock market plummeting over 3,000 points after Sunday’s historic rate cut, the actions of the Fed meeting didn’t do much to quiet investor concerns.

And there’s another question emerging in the current low rate environment — will lenders actually allow mortgage rates to go lower?

Remember, lenders are needing time to work through the backlog of applications that accumulated as rates fell.

Until lenders start to clear out their pipelines, it’s doubtful rates will drop very quickly.

Will mortgage rates go lower? Maybe, but there’s no guarantee

Fortunately, many experts are predicting that mortgage rates will fall back into the low 3’s.

But this isn’t something that will happen overnight, nor is it a guarantee.

If you’re considering refinancing, it’s a good idea to get the paperwork filled out now so that you’re in a position to take advantage when rates dip again.

But don’t make the mistake of trying to time rates.

If you feel like you can save money, it’s worth locking your rate so that you can take advantage of mortgage rates that are at their lowest average in 50 years.

Verify your new rate (Oct 31st, 2020)