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.

Each line represents a different 30 year fixed mortgage note rate.  The numbers on the right vertical axis are the origination closing costs, as a percentage of your loan amount, that a borrower would be required to pay in order to close on that note rate. If the note rate graph line is below the 0.00% marker, the consumer may potentially receive closing cost help from their lender in the form of a lender credits. If the note rate line is above the 0.00% marker, the consumer should expect to pay additional points at the closing table to cover permanent buydown costs and origination fees. PLEASE SEE OUR MORTGAGE RATE DISCLAIMER BELOW

CURRENT MARKET: The "Best Execution" conventional 30-year fixed mortgage rate is 4.875%. If you are looking to move down to 4.75%, this offer carries higher closing costs but could be worth it to applicants who plan on keeping their new mortgage outstanding for longer than the next 10 years.  Some lenders are beginning to price loans more aggressively because competition is tight, so scattered sightings of 4.75% are possible, but not on a wide-spread basis. Ask your loan officer to run a break-even analysis on any origination points they might require to cover permanent float down fees. On FHA/VA 30 year fixed "Best Execution" is still 4.75%.  15 year fixed conventional loans are best priced at 4.25%. Five year ARMs are still seen best priced at 3.50% but the ARM market is more stratified and there is more variation in what will be "Best-Execution" depending on your individual scenario. 

CURRENT GUIDANCE (same as yesterday due to markets being closed today):  Today's market movements did nothing to change the guidance we presented yesterday which suggested two possibilities.  The first possibility is that that recent improvements in rates are on hold until after next week's FOMC Announcement (Fed meeting) as past precedent suggests that bond markets may fear the Fed will indicate some sort of acceleration of rate hike prospects, which would be negative for rates.  The other possibility is that the announcement will contain no such "scary" indication, which suggests rates either return to current levels or improve.  Either way, we view floating as risky given the uncertainty of that situation in combination with the fact that the 4.875% Best-Execution rate which we know will be a hard barrier to break.  So although longer term, more flexible outlooks can still float in speculation of further gains, the upside is limited enough for shorter term outlooks to favor locking.

What MUST be considered BEFORE one thinks about capitalizing on a rates recovery?

   1. WHAT DO YOU NEED? Rates might not recover as much as you want/need.
   2. WHEN DO YOU NEED IT BY? Rates might not recover as fast as you want/need.
   3. HOW DO YOU HANDLE STRESS? Are you ready for MORE VOLATILITY in the bond market?

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"Best Execution" is the most efficient combination of note rate offered and points paid at closing. This note rate is determined based on the time it takes to recover the points you paid at closing (discount) vs. the monthly savings of permanently buying down your mortgage rate by 0.125%.  When deciding on whether or not to pay points, the borrower must have an idea of how long they intend to keep their mortgage. For more info, ask you originator to explain the findings of their "breakeven analysis" on your permanent rate buy down costs.

Important Mortgage Rate Disclaimer: The "Best Execution" loan pricing quotes shared above are generally seen as the more aggressive side of the primary mortgage market. Loan originators will only be able to offer these rates on conforming loan amounts to very well-qualified borrowers who have a middle FICO score over 740 and enough equity in their home to qualify for a refinance or a large enough savings to cover their down payment and closing costs. If the terms of your loan trigger any risk-based loan level pricing adjustments (LLPAs), your rate quote will be higher. If you do not fall into the "perfect borrower" category, make sure you ask your loan originator for an explanation of the characteristics that make your loan more expensive. "No point" loan doesn't mean "no cost" loan. The best 30 year fixed conventional/FHA/VA mortgage rates still include closing costs such as: third party fees + title charges + transfer and recording. Don't forget the intense fiscal frisking that comes along with the underwriting process.