March 2, 2020
But Orion’s brokers know that coronavirus fears have sent bond yields tumbling, evidenced by both the 10-year and 30-year yields breaking through record lows in the past week. The average on the 30-year fixed rate mortgage, which loosely follows the yield on the 10-year Treasury, fell Friday morning to 3.23 percent, an 8-year low, but not a record. (The record lowest average on the 30-year fixed rate mortgage was set back in September 2012, when it touched 3.15 percent.) Times are very good for borrowers, and their brokers, at the moment, but some of our brokers report that their clients are wondering why mortgage rates aren’t even lower.
Mortgage rates are not falling quite as fast as Treasury yields both because of how quickly Treasury yields have dropped, as well as the current heightened risk to investors in purchasing mortgage-backed bonds (MBS). The historical difference in price between Treasury bonds and mortgage rates is due to risk. (We like to think that all of our broker’s clients are risk-free, but investors don’t share that opinion.) Unlike Treasuries, which can’t be paid off early by the government, mortgages can be paid off early when borrowers refinance. Mortgage investors pay a premium for MBS to receive higher monthly interest payments from borrowers over time, but when borrowers refinance, which is typically in the borrower’s best interest, investors subsequently lose monthly interest payments and years of potential profit.
The faster mortgage rates fall, the higher the risk of prepayment for investors increases, as borrowers across the nation hear about a “refi boom.” And no one wants to pay 103 for a loan or security that pays off at 100 in four months.
How do investors who buy mortgages respond? Since they are that much more worried about losses from a refinance boom, the result is they begin to pay less for mortgages, and those premiums decline. As the premium investors pay goes down, the price for borrowers begins to go up, in either up-front costs or higher interest rates.
Because mortgage investors have to worry about borrowers paying their loan off too quickly, it is actually common to see mortgage rates tread water as Treasury yields drop, even to all-time lows. Given enough time and market stability, mortgage rates eventually follow Treasury yields, but as is currently happening, sometimes mortgage rates do fall, but not as much as Treasury yields. And we at Orion hope that the world health organizations reign in this potentially deadly virus.