Tuesday, May 5, 2009

Mortgage spreads are getting very tight

Since the end of last year, 10-year T-bond yields have been moving higher, while yields on MBS securities have been falling. As a result, the spread between the two is getting down to a level that is almost as low as we have seen in the past 20 years. That means that yields on conforming mortgages are unlikely to fall further (conforming rates are largely determined by the yield on FNMA current coupon mortgage-backed securities), unless the economy takes another turn for the worse and Treasury yields fall. As the second chart shows, conforming mortgage rates are now as low as they have ever been, and there is still plenty of room for Jumbo mortgage rates to fall, however, even if conforming rates rise. I don't see any thing in these charts that will hurt the housing market to any significant extent in the near future.

Message to potential homebuyers: housing prices have fallen significantly in many markets, and the cost of borrowing for the average house has never been so cheap; if you have been waiting for a good time to buy, now is as good a time as ever. For higher end markets, where price declines have generally lagged the declines in the heavily overbuilt markets, borrowing costs are likely to fall some more, so you might want to hold out for better bargains in coming months.

With fixed rates so low, both nominally and historically, I would recommend getting a fixed rate mortgage instead of a floating rate. Short-term interest rates could move sharply higher in coming years when the Fed reverses its currently super-accommodative policy stance.


Bill said...

Scott: Should the target rate for once looking to refinance a jumbo mortgage be in the 5 to 5.5% range? What do you think?

Bill said...

"one" not "once". Sorry for the type-o.

Scott Grannis said...

The refi decision depends a lot on the transaction costs of doing it, coupled with your expected ownership horizon. You'll have to juggle those numbers yourself, keeping in mind also that if you refi too soon, and rates continue to fall, you can always refi again and lock in a lower rate. The nice thing about fixed rate mortgages is that you have the option of refinancing at a relatively low cost, so your upside is pretty unlimited as rates fall, but you are absolutely hedged against the downside risk of rising rates.

Having said that, I would think 5.5% would be a mighty attractive rate to lock in. Maybe you get lucky and rates go to 5%.