Why are interest rates on 30-year fixed-rate mortgages rising even as the Federal Reserve slashes interest rates???

Mortgage and Lending with Free State Mortgage, LLC


 Man Yelling

Many of you have been asking, why are fixed rates still remain high when the Federal Reserve has been lowering them?   

The moral:  Your money is worth less to banks (interest paid to you by banks) but to borrow this money, comes at a higher rate.

The answer is that the mortgage market is short of roughly $1 trillion in capital, according to Paul Miller, an analyst at Friedman, Billings, Ramsey. The modern mortgage market works with borrowed money. Investors, including hedge funds and mortgage real estate investment trusts, buy mortgage securities, but finance a lot of their purchases with this borrowing ability.  Miller estimates that $11 trillion of outstanding U.S. mortgage debt is supported with roughly $587 billion of equity.  THESE NUMBERS DON'T ADD UP!  SEE THE PROBLEM???

But last year's sub-prime meltdown has lowered confidence in home loans that back these mortgage securities. Now the banks that finance most of these mortgage investments have started to pull back and impose margin calls, demanding more cash or collateral to back their loans. (IN OTHER WORDS, MAKING LESS AVAILABLE MONEY.)  Furthermore, the money that IS available, is going to have to be high quality loans.

This has sparked a mortgage investors have to sell assets to meet margin calls. Forced selling pushes prices lower, sparking more margin calls, which in turn produces more selling and even lower prices (THIS IS WHERE BANKS ARE LOOSING MONEY.)

When debt prices fall, yields rise, and that's what's happening to mortgage securities - even those backed by government sponsored entities including Fannie Mae "The immediate impact is that interest rates on 30-year fixed-rate mortgages will have to increase relative to Treasuries," Miller wrote in a note to clients on Friday. "That is why we are experiencing pressure on mortgage rates despite the downward movement on the 10-year bonds."  Rates on 30-year fixed mortgages usually follow the movement of 10-year Treasury bonds, but this relationship has broken down as de-leveraging in the financial system takes hold.

There are two ways to resolve the problem. Either inject $1 trillion of new capital into the mortgage market, or allow prices of mortgage securities to fall (and interest rates on home loans to climb), Miller said.  The mortgage market won't be able to raise $1 trillion, so prices have to fall, he warned.  "There is no quick fix here," the analyst said. "It will take about six to 12 months for the pricing pressure to alleviate on these mortgage assets."

"This will be painful, but it must be allowed to play out in an orderly fashion in order for the mortgage market to achieve equilibrium," Miller concluded.

Comments (4)

Karen Cooper
Karen Cooper | Sr Mortgage Loan Originator ! NMLS # 223305 | First Federal Bank of Florida, Ocala, FL - The Villages, FL
Helping Homeowners w/Home Loans in 27 US States
Daniel - Working with first time home buyers, I get asked this question A LOT! Thanks for a detailed breakdown on factors associated with this.
Mar 10, 2008 08:32 AM
Daniel Eckenrode
Free State Mortgage, LLC - Hagerstown, MD
Just think if the Fed had not lowered rates, we probably would be in the high 7's now. 
Mar 10, 2008 08:48 AM
Bob Carney
Taylor-Made Deep Creek Vacations & Sales - Mc Henry, MD
Licensed MD/PA Real Estate Agent

Painful...yes.  But it should have been more painful when the mortgages were being handed out a few years ago.  Actually coming to the settlement table with money saved up for a home...

Lower interest rates actually lower the value of our money overseas...double edge sword.

Thanks for laying it down for us. 

Mar 10, 2008 11:57 AM
Karen Cooper
Karen Cooper | Sr Mortgage Loan Originator ! NMLS # 223305 | First Federal Bank of Florida, Ocala, FL - The Villages, FL
Helping Homeowners w/Home Loans in 27 US States
Daniel - Due to that "double edged sward" Bob references, the past several Fed Funds/Discount Rate lowerings by The Fed took us right out of the 5's and into the 6's, and I think 7's aren't far away from us. That's what my crystal ball shows :->
Mar 12, 2008 02:31 AM