In response to the unprecedented challenge of COVID-19, the Federal Reserve has significantly loosened monetary policy this month, putting the lower bound of its target range at 0%. Meanwhile, yields on Treasury securities, while volatile, have fallen as well.
But these declines haven’t translated into a decrease in mortgage rates. In fact, mortgage rates have increased this past week and, generally, are higher now than they were at the end of February. Why?
- The Fed works on the short-side of the market: The Fed’s rate cuts act on the extremely short-end of the market – its target rate is for overnight loans that financial institutions make to each other. Mortgage loans, on the other hand, are priced on the basis of the longer-term side of the financial market.
- Mortgage securities face pre-payment risks: Generally speaking, mortgage lending is funded by selling mortgage-backed securities (MBS) on Wall Street. Borrowers, through the mortgage banking system, get the funds to purchase a home, and investors get an asset that generates a monthly cash flow as borrowers make their monthly principal and interest payments. But borrowers can also completely pay off their mortgage early, as they do when they sell a property or refinance their existing mortgage. The pre-payment risk inherent in MBS generates an uncertainty that’s not a factor with Treasury securities. During the recent market upheaval, investors are turning to Treasury securities, driving down yields on Treasury securities. Because of the pre-payment risk and the anxiety about the economic outlook, rates on MBS need to be even higher than usual over Treasurys to continue to attract investors.
- Mortgage industry capacity squeezed: The mortgage industry simply doesn’t have the capacity to handle the influx of applications coming in due to the low mortgage rates. The industry as a whole was already under stress with the low mortgage rates in January and February. Appraisers, underwriters, originators, title attorneys, processors, and others were stretched to take care of the customers in the pipeline before the end of February. An even lower mortgage rate across the industry would add fuel to the fire, negatively impacting customer service and leading to a rise in missed closing dates.
This is an article from a newsletter from a Wells Fargo agent I just received on March 23, 2020.