How does a lender decide a mortgage rate? In part it’s the buyer’s credit score and other traits, but it also depends on a bank’s investments, outlook and mortgage bonds.
NEW YORK – A number of different variables can impact the rates a lender offers to homebuyers. One important input, for example, has nothing to do with the buyer – how much mortgage-backed bonds are fetching in the market.
If mortgage bonds are in demand, it can lead investors to buy more mortgages at lower interest rates. Conversely, if mortgage bonds don’t see much demand, it puts upward pressure on mortgage rates.
Currently, mortgage bonds seem to be struggling. The spread between them has widened since earlier this year and remains over two-thirds wider than historical norms, at about 1.6 percentage points at present versus less than 1 point on average over the past two decades.
Meanwhile, many homeowners are now effectively “locked-in” to the mortgages they got at rock-bottom rates back in 2020 or 2021, which will likely subdue home-buying activity, according to economists at Fannie Mae. The result of home longevity? The lifespan of mortgage bonds gets longer as fewer people prepay by selling their homes or refinancing. This means the bank owning a mortgage-backed bond is also locked-in longer to whatever rate that bond was paying when they bought it – which might now be below the rate that depositors are demanding on their cash.
The absence of a huge buying force in the market could also help keep the mortgage-bond-versus-Treasury gap bigger than it might otherwise be.
“It is possible that spreads settle out at wider levels than we had previously expected,” analysts at KBW wrote recently.
Source: Wall Street Journal (03/29/23) Demos, Telis
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