By Catie Clark
BridgeTower Media Newswires
The mortgage markets have seen two percentage point increases in less than a year and some shorter-term mortgage types have sprouted interest rates that can exceed those of longer-term 15- and 20-year fixed-rate products. These curve-inversion behaviors are uncommon, and it may take home-buyer education and savvy maneuvering in order to navigate this rapidly changing marketplace.
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Curve inversion
One term thrown around a lot right now is curve inversion. In normal economic conditions, interest rates of shorter-term loans are lower than long-term loans. The rate of a 30-year fixed rate mortgage is usually higher than the rate of a 15-year mortgage, which in turn will be higher than a 7/1 adjustable-rate mortgage (commonly called ARM). Likewise, the interest rates on 2-year Treasuries will be lower than 5-year Treasuries, which will be lower than rates on 10-year Treasuries, and so on.
When economic pundits refer to the big-bugaboo of curve inversion in the context of recession, they are specifically referencing when the interest rates of 10-year and 2-year Treasuries switch places and subtracting the 2-year rate from the 10-year rate yields a negative number. This is the curve inversion condition that the economic professionals point to as a signal that a recession is likely in the next one to two years. A Treasuries curve inversion has preceded every major recession, as defined by the National Bureau of Economic Research, which is the official arbiter of recessions. But what does this mean for mortgages?
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Treasuries, inversion and mortgages
The greatest governor of mortgage-interest rates is the 10-year Treasury constant maturity rate. The reason is simple: on average, most mortgages are held for less than 10 years.
“Most people do something with their mortgage every eight years,” explained Jared Cook, regional sales manager at Zions Bank in Boise, Idaho. “The average duration of a mortgage is eight years. It’s not really 30 or even 10. When we’re talking about a 10-month adjustable-rate mortgage, someone usually does something with that before 10 years are up, so that’s what the whole industry is based off.”
Mark Vintner, senior economist at Wells Fargo Bank, remarked: “Rates on 30-year fixed mortgages are typically no more than two percentage points over the 10-year Treasury. They’re now about two and a half percentage points over the 10-Year Treasury. So I think that’s one outcome of the inverted yield curve: spreads have widened.”
Spreads tend to widen when there is uncertainty in the lending market — which can explain the situation now — and when rates on U.S. Treasuries fall faster than lending markets can react, which was the situation between March and July 2020 at the height of the pandemic economic downturn.
Generalities aside, the mortgage-Treasury spread is also affected by more complex factors. As Vintner explained: “I think one of the reasons that spreads widen is there’s a lot of concern that the Federal Reserve (the Fed) is going to have to sell mortgage-backed securities in order to shrink their balance sheet, because they’re not going to see as many securities mature and roll on.”
Getting into the Federal Reserve’s policies over mortgage-backed securities is an article for another day. The bottom line remains that the 10-year Treasury and its spread with the 30-year fixed mortgage rates drives mortgage interest overall.
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Long-term mortgage trends
Will mortgage rates remain high relative to the bargain rates of the pandemic? Vintner said he believes this is the case: “I think a lot of folks have been spoiled into believing that mortgage rates below 5% are the norm. In reality, I don’t think that we’re going to see mortgage rates meaningfully below 5% anytime soon, unless we’re in some extreme recession where the Fed has to drive interest rates down to zero again…I think that over the next 20 to 30 years, we’re likely to see a little bit more inflation than we did the last year. And interest rates are likely to be higher than what we became accustomed to in the 20 years prior to the pandemic.”
“So I tell folks what looks like close or at the top of the market, home prices are beginning to come off a little bit,” he continued. “But if you find a house you like at a price you like, the mortgage rate really shouldn’t get in the way of you buying that home. Because rates (can) go down from here and you can always refinance.”
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Short-term trends and curve inversion
When the federal yield curve inverts, it tends to cause occasional mortgage interest rate inversions. That’s because bankers who set rates tend to react to economic conditions in ways that are similar to how the Treasury bond markets behave.
Cook explained how curve inversion has been causing mortgage-rate inversions and uncommon rate fluctuations: “Setting the prices (for mortgage rates) is up to our CFO, but what we usually do is judge it based off of what the 10-year Treasury is doing. So for our 10/1 ARM, we raise it when the 10-year is going up significantly and we lower it when the 10-year is going down significantly ... (The 10-year Treasury) has been a roller coaster ride these past couple of months. It’s shot up dramatically, went back down, and now it’s kind of trending down, and we’ve just kind of followed it all throughout.”
“Where the yield curve inversion has affected ARMs is on the short-duration ARMs,” he added. “Here’s 3/1, 5/1 ARMs with their price the same as a 10/1 ARM because of that yield curve inversion.”
Currently, the inversion in longer-term mortgage rates doesn’t strictly reflect the negative inversion in the 10-year and 2-year Treasuries. This is a different situation from 2020-21 — in the wake of the 2019 federal yield curve inversion — when the many under-10-year ARMs had interest rates higher than a 15-year fixed mortgage, and briefly with 30-year fixed mortgages.
“There’s still a spread between a 10/1 ARM and a 30-year fixed,” Cook said. “For instance, today’s (Aug. 26) national average for a 30-year fixed is 5.8% and a 10/1 ARM national average is 4.75%. So if an individual was buying a home for $500,000 with 20% down and excellent credit, at that 5.8%, you would pay $2,367 in principal and interest per month and the difference between that and a 10/1 ARM is that the 10/1 ARM is just over $300 savings per month.”
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Buyer strategy
Cook observed: “What we’re seeing is relief for homebuyers (because) for the first time in probably two years, they’re able to negotiate. They’re not going up against multiple offers, so it’s a great opportunity for a lot of homebuyers to get into homes right now who were kind of bullied out of the market during the last couple of years with cash offers.”
“I’m a firm believer (for) homebuyers getting education,” he continued. “Homebuyers should be talking to a loan officer and seeing what their options are without just assuming that they can’t buy a home.”
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