Understanding How Mortgage Markets Are Priced

Mortgage rates have steadily increased since the start of 2022. During the last week of September, average 15-year fixed and 30-year fixed mortgage rates climbed to their highest levels in fifteen years.

While recent actions taken by the Federal Reserve to slow down the economy and reduce inflation have had an undeniable impact on current mortgage rates, this isn’t the only factor driving mortgage market pricing. The cost of mortgage-backed securities can have a direct impact on residential mortgage rates. This is because mortgage companies lose money when they issue loans when the market is down. When the price of MBSs drop, mortgage providers typically increase mortgage rates. When the price of MBSs goes up, mortgage rates go down.

Recently, we had the opportunity to speak with Judy Downey-Fortson, an experienced loan originator with Loan Depot Builder Division. She gave us her opinion on what happened with the mortgage markets at the end of September.

Can you tell us about your experience in the real estate market?

“Being a loan originator is a lot like working on a production (assembly) line. As an originator, my work places me in the middle part of ‘the line’.  Up the line, is the secondary market group working with the mortgage-backed security market (MBS). Down the line is the servicing and securitization group.  It’s not actually a line, but a circle when you have loans that need to be securitized.”

Can you explain what mortgage-backed securities are?

“Mortgage-backed securities (MBS) are like buckets full of loans which investors purchase. The price these investors are willing to pay constantly changes.  The difference between each bucket is a ½ point in rate. These are referred to as coupons. The loans that can go into a bucket (coupon) can be as high at 1.125% above the coupon’s value.  For example, a 5% bucket (coupon) will contain rates up to 6.125%.  So, rates at 6.25% would need to go into a different or higher bucket.”

“As loans are placed or secured in each bucket, there is a good understanding for what investors will pay for that bucket. This understanding is based on recent MBS sales.”

What causes the higher discount point costs reflected in recent rates?

“Mainly its Inflation.  As rates increase, a new bucket needs to be re-introduced. This is called the 7% bucket and it hasn’t been seen for over 20 years. So, now the question on everyone’s mind is what, or if, investors will pay for a 7% coupon.  There is no recent history of this 7% bucket.  This means the value of this new bucket is either big time gambling or speculation.”

“Investors make their returns off a ‘hold time’ for the investment. Prepaying a mortgage or refinancing to a lower rate could mean the investor does not make a return. If investors believe that rates will be coming down in the next 12-18 months, they may pay more for the 6.5% bucket, even though it will have a lower return then the new 7% bucket.”

“In 2019, there was a spike in rates which lasted about 8 months. Rates fell quickly in 2020 and a refi boom happened.  The investors who bought the higher rate buckets experienced losses due to rapid refi’s and shorter holding times on those buckets of funds.  Therefore, we are not seeing rates being offered at a premium (at zero points or rebate to the customer).”

So, what happened during the last week of September? 

“Global economics and England were the spark.  Prior to the first week of September, England announced that it would be implementing large tax cuts. Think of putting money in peoples’ pockets for them to spend. That’s a key ingredient to fuel inflation. Worldwide investors feared that it would ignite more inflation and bring about a deeper recession. This is the main reason we had volatile reactions in our own U.S. bond market.”

“On Monday, September 26th, large tax cuts were announced, and the bond market tanked over a full point. This caused mortgage rates to skyrocket and lenders to reprice multiple times and face rates that came with points”.

“By September 28th at 1 p.m., revisions were made to the UK policy and a new bond purchasing program similar to quantitative easing in the U.S was introduced, and the market drastically improved. This unexpected new bond purchase program in the UK was the trigger needed to reverse the powerful trend in MBS markets today.”

With the resignation of England’s new PM after only 45 days, we’re seeing an extremely volatile global market that’s struggling with inflation.  Bond yields were well over 4% and dropped back down to around 3.7%, which provided better pricing.”

What’s the best course of action for homebuyers?

“ARM loans or 2/1 buydowns as we anticipate rates to improve in the next 12-18 months. Adjustable-rate mortgages are great for people that plan to pay off their mortgage quickly or expect to sell their home in a short amount of time. However, these loans do have slightly tighter ratios for qualifying.”

If inflation continues to increase and rates keep going up, homebuyers could face higher interest rates and higher monthly mortgage payments. Anyone looking to buy a home should lock in a lower mortgage rate now.”

Thank You, Judy for such an insightful look at the market!

Strategic Sales and Marketing offers a variety of real estate sales and marketing services. Our team has years of experience working with the real estate industry and understands the steps required to identify and connect with potential buyers. Please contact us for more information about our services.