Mortgage Rates

Mortgage Rates: High-Risk Event Ahead





Mortgage rates are unchanged today as bond markets are closed for Good Friday.

Yesterday, wewrote that loan pricing was in a holding pattern until next week when the market faces a high-risk event, a Federal Reserve meeting. We expect this event to better dictate the direction of mortgage rates in the short-term.

"Holding pattern" doesn't necessarily provide an accurate bias regarding locking or floating as it would tend to suggest some sort of 50/50 scenario with equal chances of rates moving higher or lower. But in all actuality, it will be tougher for mortgage rates to move lower than it would for mortgage rates to move higher. We've talked about why that is the case many times over the past four months. This is the technical explanation we've offered:

"Lenders have moved the Best Execution 30-year fixed note rate as low as they possibly can without drastically altering their pipeline hedging strategies. This is a factor of what production mortgage-backed security coupon is most liquid in the secondary mortgage market. On conventional loans, the 4.50 percent MBS coupon is the hedging vehicle of choice for lock desks. Home loans with note rates between 4.875 and 5.25% are generally used to fill 4.50 percent MBS coupon trades. Until MBS investors demonstrate sustainable demand for 4.00 percent 30-year fixed MBS coupons, lenders will not find it economically efficient to quote 4.75 percent note rates without expensive permanent buydown costs. From that perspective, if you are floating a conventional home loan interest rate, you should not be expecting further improvements to your actual rate in the short term. If the bond market recovery rally continues, closing costs will improve, but on the whole, it will take a sustained move higher in 4.00 percent MBS coupon prices for Best Execution to dip below 4.875 percent."

And here's a simpler way to think about it. Any time someone gets a mortgage, the lender that fronts the money to fund that mortgage throws the borrower's monthly payment in a mortgage-backed security bucket with loans of similar credit quality and rate. For example, home loans with 4.875-5.25% interest rates tend to end up in the same buckets. That is the bucket where a vast majority of mortgages are ending up these days. This bucket has an effective monopoly on mortgage rates and it's simply not safe business for lenders to offer rates that can't fit inside it.

It's possible for lenders to shift mortgage rates into a new, lower bucket, but it takes much convincing in terms of a sustained bullish movement in the bond market. The need for a broad-based shift in lender bucket preference is what puts up a high level of resistance when "Best Execution" mortgage rates seem like they should be moving lower at a faster pace. This is exactly the reason we say it's not the kind of thing you want to plan on until it begins to happen. In other words, it doesn't make much sense to kid-proof your house unless you have kids or have one on the way!

The earthquake crisis in Japan was the only time in recent history where it seemed like this unlikely shift had a chance of occurring. But as the worst-case-scenarios became less likely, lenders quickly returned mortgage rates to their most cost-effective "bucket" (which is based on a variety of technical factors).

Take a look at our most recent chart of the average origination costs tied to specific interest rate quotes (based on the offers from the five major mortgage lenders). You can see at a rate of 5.0% for instance, that current rates are near their best levels of the year with the exception of one day in January and the two most panic driven days of the Japan Crisis in mid-March.

If the note rate line is moving up, the closing costs associated with that note rate are rising. As you can see, consumer borrowing costs shot higher last week before reversing course this week.