Mortgage interest rates are much higher than usual compared to long-term government bond rates. Mortgage industry experts are wondering if spreads will return to normal. This means that as long as government bond rates remain stable, mortgage rates will continue to fall. It will probably happen, but it won't happen in 2023. Prior to the pandemic, the average spread across all available data was 1.69 percentage points. For example, in February 2019, a 10-year government bond paid 2.68% interest. The average homeowner cost for a 30-year fixed-rate mortgage was 4.37%, a difference consistent with the long-term average of 1.69%. Spreads typically range from 1.5% to 2.0%.
A homebuyer goes to a mortgage lender (usually a mortgage broker or bank) who offers an interest rate. The originator then sells the loan, usually to a government-backed agency such as Fannie Mae or Freddie Mac. Mortgage lenders, like other brokers, get paid for this service. Originators receive cash equivalent in value to drive up interest rates. For example, the average mortgage interest rate in the first week of 2020 was 3.72% for him. The average interest rate Fannie Mae paid investors was 2.61%. What happened to the 1.11% spread between these two rates? This allowed mortgage lenders to pay for their services. This payment can be thought of as a retail mortgage spread.
Of course, if Fanny or Freddie sell mortgages to investors, the interest rate will depend on supply and demand. Investors generally view mortgages as inferior products compared to government bonds. Both are considered safe, but the US Treasury will continue to pay interest for the life of the bond. However, homeowners can refinance when mortgage rates drop. A refinancing option means the homeowner will refinance when interest rates drop. Investors no longer own old mortgages with high interest rates. Instead, investors now have cash to reinvest at new lower interest rates. Investors don't like it.
Rising interest rates create problems for investors too. No one is stuck with old low interest mortgages that don't pay off early. They want to get their money back and buy some new high-yield mortgages, but it hasn't happened.
Mortgage-backed securities become a disadvantaged investment option as homeowners can refinance their mortgages. Therefore, investors will buy them only if they offer a premium over the interest rate on government bonds. This is a wholesale mortgage spread.
Total spread is the sum of retail and wholesale spreads at any point in time. Headline spreads widened significantly in the first half of 2020 as the Federal Reserve cut interest rates and the government sent out stimulus checks. Homeowners refinanced their mortgages to take advantage of lower interest rates. Apartment dwellers began to buy housing. This was made possible by cash in bank accounts and low mortgage rates. Mortgage lenders were flooded with business. They couldn't handle all the mortgage refinancings the public wanted, at least not immediately. As they hired staff and trained new recruits, they increased their profit margins. Retail spreads increased significantly, while wholesale spreads increased slightly. This was documented by William Emmons of the Federal Reserve Bank of St. Louis.
The wide overall spread between mortgage rates and government bonds in early 2023 is likely due to wholesale levels. Fixed income traders cite interest rate volatility as an important factor. Keep in mind that rising interest rates mean fewer upfront payments, which is what mortgage-backed security owners want most. Falling interest rates mean that mortgage-backed security holders are getting most of their advances when they least need them. Therefore, the prospect of interest rates moving in either direction is keeping investors away from mortgage-backed securities.
Spreads are expected to widen at the retail level due to mortgage lender interest rate risk. The borrower receives an interest rate offer, but walks away when interest rates drop, abandoning the original originator. But when interest rates rise, that borrower keeps the quota on the originator. Both spreads widen in a more volatile interest rate environment.
Mortgage rate volatility has doubled in the last 52 weeks compared to his previous 52 weeks (measured as the standard deviation of the absolute value of the weekly interest rate change).
When will this wide spread normalize again? Whether or not interest rates are stable is very important. That's after the Federal Reserve completed its tightening and then returned to a stable path for interest rates going forward. It seems that further tightening is imminent from March 2023. And maybe in 2024, the Fed will cut rates to reopen the economy. If interest rates reach levels that last for many years, spreads will tighten.
If you're considering a homebuy due to the cost of a mortgage, or if you're a new homeowner looking to refinance your mortgage, the actual mortgage rate will change whether the Fed starts easing. , may decline prematurely in anticipation of easing. Mortgage rates will fall even if spreads remain wide. If spreads tighten, it will put more downward pressure on mortgage rates. Mortgage interest rates will therefore likely decline gradually over the next two years, starting in early 2024.
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