The prevailing rate on 30-yr fixed-rate mortgages hasn't changed much since early July, despite a 40 bps drop in 10-yr Treasury yields. This rising spread could be telling us that investors on the margin are unwilling to buy MBS that are yielding less than 3.5%. That would be a rational response to the ongoing decline in high quality bond yields—at some point you figure that yields are so low that the risk/reward of owning bonds at lower yields is just too high. Homeowners who lock in today's 4.7% 30-yr fixed rates can refinance almost without cost should rates fall further (to the detriment of investors), but they can laugh all the way to the bank for years and years if rates rise (also to the detriment of investors). That's because the duration of MBS bought today could extend hugely if rates start rising, resulting in outsized losses to MBS investors; MBS prices are going to be much more sensitive to rising rates than T-notes or T-bonds.
But the more important development in the past month or two is that the spread between jumbo and conforming mortgage rates has narrowed to about 40 bps. At the height of the financial market panic in late 2008, when 10-yr Treasury yields collapsed to a mere 2.05%, the spread was an outsized 170 bps. In "normal" times the spread tends to be about 20 bps.
When the spread between jumbo and conforming rates was super-wide, it was a sign of a dysfunctional bond market—lenders unwilling to lend at almost any price, and that was a big factor contributing to shut down the housing market. Now that the spread has come down to almost-normal levels it is a sign that the bond market has largely regained its footing. Yield-hungry banks and and investors spotted the huge incremental yield advantage of the jumbo sector and stepped in to fill the gap, offering loans to buyers of expensive homes. They have earned a substantial reward for doing so.
The bond market is operating more efficiently now, and that's a good sign, because it makes the economy healthier. And it also means that the housing market—particularly for high-end homes—has much better support.
You wrote "Homeowners who lock in today's 4.7% 30-yr fixed rates can refinance almost without cost should rates fall further"
ReplyDeleteHow is this so? You would still have title insurance, escrow, recording, appraisal, credit
report...all your normal closing costs. And on top of this, a typical fee to the bank/broker would be at least 1% of the loan amount.
If you can knock 0.5% to 1.0% off your 30-yr rate (i.e., save that much per year for 30 years), then the savings overwhelm the cost of refinancing. The almost-free refi option that most homeowners enjoy is something that is very underappreciated, and also something that is underpriced, typically, by the bond market.
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