Many potential home buyers have been a bit confused lately about everything going on in the mortgage industry. In an effort to assist our clients and other readers, we are beginning a series of blog articles that focus on mortgage education.
For this article, we interviewed one of our trusted Denver mortgage professionals, Jonathan Mather of Clarion Mortgage Capital.
Q: Did the Fed just cut mortgage rates?
A: According to many of the calls we have been receiving, there are many people out there who think this is the case. However, over the last few rate cuts in this Fed cycle, the mortgage rates have actually gone up after a Fed Funds Rate Cut.
Q: So what is going on here and why the difference?
A: Let me first lay a little groundwork in the economics of mortgages. Mortgage rates are based off bond sales prices and yields, not the Fed as commonly believed. These bonds are sold as MBS’s, Mortgage Backed Securities and are sold in the bond market in large pools. I can explain more about MBS pricing later.
Bonds are debt securities which require the borrower to pay back a specific amount of principal and interest at a specific date. Bonds are widely seen as safer instruments of investment than stocks(more on this later) The rates are determined by the yield of the bond.
Q: What is the yield?
A: Simply put it is the expected return to the purchaser of the bond. The price and yield are inversely related; as the price goes up, the yield goes down. Interest rates are based on the yield of these mortgage backed bonds
Inflation is not good for bonds, which is why rates rose last fall when the Fed was concerned about inflation. Inflation is when too many dollars are chasing the same goods and services; i.e. bidding up the price. This erodes the value of a fixed instrument like a bond because; they have a guaranteed payout at maturity.
Q: What determines MBS pricing?
A: MBS pricing is affected by several market factors. The large Government Sponsored Entities(GSE); Fannie Mae, Freddie Mac and Ginnie Mae sell the majority of high quality MBS pools in the US. As said before, these are viewed as relatively safe investments because of the implied backing (explicit for Ginnie) of the US Government. Some of the main pricing components are:
- Capital Flows: money flows to safer investments when the stock market or economy is doing poorly- hence the rates dropped when the stock market tanked in late January.
- Economic Data- Obviously this is linked to capital flows, bad news is good for rates. Fed Rate cuts were seen as market centered rather than economy centered
- Foreign Exchange rates; foreign demand for U.S. bonds fluctuates with exchange rates making our bonds more and less attractive to investors.
The recent Fed rate cuts have been viewed as market centered; to keep the stock market happy. It is widely believed that the Dow would be 1000 points or so lower without the recent cuts. Traders believe this would have a deepening effect of the psychological impact of a recession/slowdown.
Q: Jonathan, what is the bottom line for potential mortgage borrowers?
A: The bottom line for potential mortgage borrowers is to be ready! If you call up a lender for the first time on the day that rates are good, you might miss out. The best way to do this is to work with a Mortgage Planning Specialist; an experienced lender who can look at where you are and where you want to be, then work up a plan with you to get there. Check your credit and apply early. This will give us time to fix up any credit issues that you may not have known about. Loan level price adjustments are having a huge effect on borrowers with so-so scores or reserves. If we sit down early, we can work up a plan and say: let's keep an eye out for this rate, when we can get it... pull the trigger. If we get all of the ducks lined up in advance, there are less chances for surprises.