Mortgage rates for homebuyers in the United States saw their biggest increase in more than a year last week, as treasury bill yields and higher inflation expectations begin to trickle down to the real economy.
The 30-year average U.S. mortgage rate was 2.99% on Friday, according to Bankrate.com, after hitting an all-time low of 2.8% as recently as February 10.
Lenders and analysts say the shift was prompted by mortgage bond investors who feared that as the virus subsides, higher growth and inflation could push interest rates higher, their leaving care losses. While bond buyers demand higher yields, mortgage lenders, who sell in the bond market, must charge borrowers more to protect their profits.
“The market is waiting two or three years and thinks rates are going to go up,” said Todd Johnson, director of Wells Fargo’s mortgage business.
T-bill yields have been rising since August, when the 10-year yield hit a 50 basis point low, but upward pressure has intensified as Joe Biden’s administration prepares for another round of stimulus economic. On Friday, the 10-year yield hit 1.35%.
Consumers, on the other hand, are scrambling to get cheap mortgages while they can, which worsens the imbalance between supply and demand. “Consumers hear about inflation and say, ‘Damn, I’d better put a mortgage on hold,’ said Paul Buege, president of Atlanta Mortgage.
In January, sales of existing homes were up 24% from the previous year, according to the National Association of Realtors. The median price of homes in the United States increased 14.1 percent year-over-year.
The fact that the mortgage market suddenly changed direction over the past week, analysts say, is due to several technical factors that made mortgage rates to return to 3% a self-fulfilling prophecy.
When rates fall, borrowers can refinance, reducing the life of their loan, but when rates rise, borrowers hold on. For mortgage bond investors, this means that in a rising rate environment, the expected life of their bonds can suddenly increase, and they often respond by selling bonds or taking equivalent action.
This “convexity blanket” puts even more pressure on the market, leading to what veteran mortgage analyst Harley Bassman has called a “convexity vortex.”
A vortex has formed over the past few weeks because there is a large cohort of mortgages expected to fall “out of the money” as rates approach 3% – meaning that the money that borrowers can save money by refinancing no longer offset the cost and hassle.
Satish Mansukhani, Head of Mortgage Securities Research at Bank of America, said: “1.25% [yield on the Treasury] was a level that we had established as seeing mortgage convexity flows, and the flows appeared just at the right time. “
A final factor is the profit margin of the lenders. When interest rates fell rapidly a year ago, demand for refinancing skyrocketed, overwhelming lenders’ ability to secure loans. This meant that lenders could keep loan prices high and achieve high margins, measured by the so-called primary / secondary differential – the difference between mortgage rates and the yield on mortgage bonds.
As lenders increased their capacity, margins fell, allowing mortgage rates to fall even as Treasury yields rose. With the spread now close to pre-pandemic levels, lenders may have concluded their margins are tight enough.
Until this week, “the initiators could reduce their margins and keep rates stable,” said Arun Manohar, analyst at Nomura. But the current level of the primary / secondary gap, at around 1.25 percent, is approaching a “fair” level of around 1.1 percent, he said.
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