The Economics of Mortgage Rates
Do you know how mortgage rates are determined?
A recurring theme we talk about here is just that, how mortgage rates are determined. The general media creates confusion for most people in not only how mortgage rates get priced but also in where they might go in the near future.
Let's break it down.
Mortgage rates available to you, the American consumer, at a base level are determined by how mortgage bonds (mortgage-backed securities) are trading. These trade daily, Monday through Friday. The main economic factor that influences whether prices for mortgage bonds are improving or worsening is how mortgage bond investors and traders gauge future inflation in the United States economy. When inflation does not appear to be a threat and/or economic growth is slowing down, we will see an improving bond market and falling mortgage rates.
However, when inflation appears to be rising, so will mortgage rates.
Mortgage rates ARE NOT determined by what the Federal Reserve does with their Overnight Rate. Anyone that thinks that is the case is simply incorrect. When the Fed raises or lowers their Overnight Rate the bond markets may or may not react. It is the reaction in the bond markets to the Fed's actions that dictates what happens with mortgage rates, in general.
That is the first step.
An all-important second step in determining where mortgage rates are each day is what is going on at the business level of the wholesale mortgage lenders. When these wholesale mortgage lenders are in need of new loan originations, they improve their pricing (lower their rates) to bring in new business. However, if their current pipeline of new business is strong there is less of a need for them to be offering lower rates.
A good example of this was found last week. When the bond markets were rallying strong on Wednesday off their reaction of the Fed's surprise 0.75 cut to the Overnight Rate on Monday night wholesale lenders were pricing the best mortgage rates available for years. Guess what happened? Many people jumped on this great opportunity and these lenders filled their pipelines with new business.
Now, these same lenders have been reducing their staff headcounts as they've moved into survival mode. Remember all the news headlines of mortgage company after mortgage company closing their doors in the second half of 2007? Well, not only did many close, but the remaining ones have shrunk down to the bare minimum of people to survive the carnage.
So, take a surge in new business and add in less people to process the new business and what do you have? You have lenders with more business than they can handle. What does that mean for you? It means that lenders have less of a business need to keep rates low and round up new business until the close the loans currently being underwritten and soon to hit the underwriters' desks.
That's why we saw rates move quickly higher on Wednesday afternoon.
Let's now look forward.
Many people are operating under the mistaken assumption that mortgage rates will be much lower this summer or later in the year. This is most likely not going to happen. Why? Because of the natural economics of the ups and downs of the interest rate marketplace. Let me explain.
Mortgage rates have been moving lower the past few months as the bond markets price in the coming recession. The Fed is now getting into gear to lower its rate as the prospect of recession becomes apparent.
Mortgage rates will hit their low point BEFORE the Fed's Overnight Rate hits its bottom. Once the bond markets feel the economy is recovering and inflation becomes the dominant threat we will see pricing worsen and mortgage rates along with it. This is how it happens because the bond markets are already pricing in the future, as they predict it, before the Fed acts.
Now, with that in mind, I predict that we will see mortgage rates dip again in late February or early March and that will be the low point of the year.
If you missed the morning dip of last Wednesday what can you do to make sure you don't miss the next dip?
Well, one of the most important things you can do is to get me the information that we need in order to lock and register your loan. Why? Well, it is a simple matter of timing and capacity. If, for some reason or another, we cannot connect by phone or email during the window of time that rates dip, you'll be out of luck. Also, when rates dip, like they did on Wednesday, I am overwhelmed with a surge in phone calls and emails by those wishing to get updated pricing and lock in their rates. I try to respond to everyone in time. Last Wednesday however, we only had 3 hours with that low pricing. That did not afford much time to talk and email with everyone, all while locking in those that already had prioritized their needs by arming me with the information and direction to act on their behalf.
This is a market where those that are looking ahead with the proper mindset about how rates get determined and prepare for opportunity are rewarded. Those operating under false impressions and wait too long to act might miss out.
I want all Mortgage Manifesto readers to be part of the former group.
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