Mortgage rates dropped noticeably since our Wednesday (Aug. 13) update. The APR for the 4.125% 30-year fixed rate moved from 4.182% to 4.140, as the rate “cost” fell 5/8 of a point.
You will often hear mortgage pricing discussed in terms of “points.” Like anything you would buy in a store, each mortgage rate has a “price” associated with it, and this price is expressed in terms of “points”. One point is equal to 1% of the total loan amounts. Two points would equal 2% of the total loan amount. And so on.
So a rate dip of 5/8 of a point on a $417,000 loan translates to a dollar value of $2,606.25. In other words, the fictional borrower would pay $2,606.25 less to obtain a loan with a rate of 4.125%. (For a guide understanding mortgage pricing, click here).
Of course, mortgage pricing is more complicated than that, and varies based on the borrower, the property, and the loan. Borrowers can pay extra for lower rates (and a lower monthly payment) or accept a rebate (cash back) from the lender to accept a higher rate, which can be used to cover closing costs or fees.
On any given day, mortgage rates typically move in small, 1/8 point increments in reaction to markets. The fact that our 30-year fixed rate fell 5/8 of a point in pricing is more significant, and has us seeking out answers.
Why Mortgage Rates are Falling
“Rates currently have downward pressure due to geo-political stress overseas, weak Q2 earnings for U.S. companies, and the Fed easing out of quantitative easing,” said Jason Grote, co-owner of Central Coast Lending.
When investors are worried or uncertain, they seek out safer investments. U.S. bonds provide one of the safest havens around, including mortgage backed securities (MBS). More activity (demand) in the MBS market will increase MBS prices and decrease yields… which means lower mortgage rates.
Partially, we are seeing this “flight to safety” help keep mortgage rates low, but to add a bit of nuance, let’s take a look at the 10-year Treasury bond.
The 10-year Treasury bond yield is often used as a point of correlation to the 30-year fixed mortgage rate (read this primer to learn why).
In 2014, the 10-year yield has dropped steadily. Larry McDonald (Forbes) and co-author Robbert Van Batenburg (Newedge) published an excellent article on Forbes explaining why the 10-year Treasury Yield has dropped to 2.40% and below, despite consensus 2014 expectations for something more like 3.44% (a full 1% difference!). This issue is an important one, and helps explain why mortgage rates are so much lower than expected.
There is a lot to say here, but we will pick out a few of the most important points:
1) Flight to safety.
As Grote said, turmoil abroad (“geopolitical risk) has sent investors towards safer investments. The only problem: U.S. Government-backed bonds are one of a shrinking number of “low risk” plays.
The alternative flight to safety assets, such as gold, oil or the dollar, have lost their reputation in recent years, due to their diminished resilience in times of turmoil.
Meanwhile, foreign demand for this safety remains sky-high:
According to U.S. Treasury data, the percentage of U.S. debt held by foreign investors was close to 34% of the United States’ total debt load as of April, 2014 vs 31% at the end of 2011.
The United States economy is exhibiting worrying signs, which reinforces the need for safety:
Measured over the same period in 2013, the US economy grew by a mild 2.4% and is expected to grow this year by 1.7%, which is the lowest GDP growth outside of a recessions year since measurements started in 1930.
2) U.S. Demographics and Politics
The baby boomers are retiring and looking for a place to park their money, and finding the U.S. bond market. Meanwhile, U.S. workforce participation continues to drop:
Today, the US civilian labor force is 155 million vs 154 million in 2007, but the US population has grown from 301 million in 2007 to 318 million this year. Net net, that’s 17 million more Americans with NO change in the size of the labor force.
The authors point out that the aforementioned forecasts that called for a higher 10-year Treasury Yield may have gone off of antiquated expectations for U.S. economic growth:
In developing their interest rate forecasts, it’s like Wall St. is focused on 20th century economic yardsticks in a drastically different post-Lehman world.
There is plenty more to read, including discussion about the effects of financial regulation under Dodd-Frank and Basel III, and the effect that a Republican-led Senate could have on the economy. Read the full piece.
Where Will Mortgage Rates Go?
Moving forward, Grote didn’t foresee any immediate major reasons for mortgage rates to move significantly: “I see rates staying at these low levels for the next couple of quarters.”
The McDonald / Van Batenburg article touched on something important when the authors wrote: “It’s like Wall St. is focused on 20th century economic yardsticks in a drastically different post-Lehman world.” As with the housing market recovery, we are not totally sure what the “new normal” looks like… and we have a ways to go before we find out.
So while buyers might expect rates to remain this low for awhile yet, the economy is more than capable of making unexpected movements. As Grote put it:
“That being said, a bird in the hand is worth two in the bush, so get these low rates while you can.”
Central Coast Lending is a California mortgage broker and direct lender based on the Central Coast of California in San Luis Obispo County. Call us at 805.543.LOAN or email us here to set up a free pre qualification. We are The Mortgage Experts: ask us anything!