Real Estate Finance News

Why Are Mortgage Rates So High? 

Below is brief explanation on what’s triggering mortgage rates to move up. 

Mortgage rates have been on the rise in recent weeks.  

This is primarily due to the stubbornly resilient inflation, an ongoing strong US economy and of course, a political showdown over the federal debt ceiling resulting in the US credit downgrade by Fitch ratings. 

NOTE- Fitch ratings is a credit rating agency that rates the viability of investments relative to the likelihood of default. Fitch is one of the top three credit rating agencies internationally, along with Moody's and Standard & Poor's.  

In times of uncertainty, another contributing factor for the 30-year mortgage rate is the gap between the 10-year Treasury Yield. This gap between 30-year mortgage rates and their closest proxy, the 10-year Treasury yield is known to economists as “the spread,”. This gap typically runs between 1.5 and 2 percentage points under normal economic circumstances. for example, if the 10-year yield sits at 4 percent, the 30-year rate should be close to 6 percent. 

Now, what’s happening? 

Over the past year and a half, spreads have gotten wacky. As of early August, the average 30-year rate was 6.84 percent, but the 10-year yield was just 3.7 percent. The gap had widened to 3.14 percentage points — or, in finance jargon, 314 basis points. That, statistically, was the highest level since 2009, when the global economy was in a meltdown. 

These days, the mortgage spreads are “abnormally high.  

In fact, current spreads match or exceed those historically seen only at times of intense crises, such as the global financial crash of 2009 and at the beginning of the Coronavirus pandemic when the world was going into lockdown. 

In both past cases, lenders and investors were afraid to take on risk, and that fear translated to an extra fee to the borrower. This is similar to what we are seeing nowadays. 

For example, your lender promises you a rate weeks before you finalize your home purchase. You lock in that rate today, even though you probably won’t find a home and close on the loan for another month or so. The gap creates a problem for your lender. If rates drop in the coming weeks, you simply ditch the loan for a better rate elsewhere. And, if rates go up, you’ll keep the loan and congratulate yourself for locking in a rate that’s favorable to you and unfavorable to the lender.  

Mortgage originators typically package their loans and sell them off to investors as mortgage-backed-securities (MBS). During the pandemic, the Federal Reserve stepped in to buy billions of dollars’ worth of mortgage bonds to stabilize the economy. This caused mortgage rates to drop as the Federal Reserve was artificially supporting the economy through their massive bond buying program. 

The Federal Reserve has stopped that bit of stimulus. And the MBS buyers are insisting on a better deal. If you lock in your rate at 6.5% today and your lender sells your loan at 7%, it suddenly looks less attractive to the investor. Again, this is all due to instability in the economy this time caused by inflation. 

The more volatile rates are the more difficult it is to hedge that rate. 

We are hoping to eventually see the US economy reach the Federal Reserves’ expected stability threshold and allow the Federal Reserve to begin lowering rates by one percent in 2024 and another one percent in 2025. This should put mortgage rates in the low to mid six percent in 2024 and mid to high 5% in 2025.