Many prospective homeowners are in a bind: Prices are high. Inventory is limited. And mortgage rates are ticking up again.
But one factor that helps determine mortgage rates offers some hope: A measure known as the spread has been falling in recent weeks after years of being elevated. If it keeps dropping, that could help send rates lower in the months ahead, although it’s unlikely to normalize completely.
Mortgage spreads are the difference between the average 30-year fixed mortgage rate and benchmark 10-year Treasury bond yields. Multiple factors go into determining a particular loan’s spread, including an individual homebuyer’s creditworthiness, the economic environment, and Wall Street’s demand for mortgages.
Historically, the difference has been around 1.8 percentage point, meaning that when 10-year Treasuries yield 4%, mortgage rates average around 5.8%. But in 2022, spreads began rising, eventually topping 3 percentage points. At the same Treasury yield, mortgage rates were suddenly more like 7%.
Spreads have stayed well above historical averages ever since, though they’ve been falling in recent weeks. They’re about 2.25 percentage points today.
“Certainly mortgage affordability is worse because spreads are wider,” said Laurie Goodman, founder of the Housing Finance Policy Center at the Urban Institute, a think tank. “Spreads will narrow, but they probably won’t go back to where they were before.”
Spreads commonly widen during financial downturns because investors grow wary of buying anything but the safest securities. But the move in 2022 was different — the economy was relatively strong. Instead, spreads widened because the biggest single buyer of mortgages, the Federal Reserve, effectively left the market.
For years following the 2008 financial crisis, the Fed bought up hundreds of billions of dollars of securities, including mortgages that were bundled into bonds, in an effort to pump money into the economy and encourage lending. It did so again in 2020 when pandemic lockdowns brought economic activity to a near-standstill.
But in 2022, the Fed stopped buying. To combat inflation, it began shrinking its holdings by letting bonds mature without reinvesting the proceeds, a process that’s ongoing. There are other big buyers of mortgage-backed securities, like banks and asset managers, but none are big enough to make up for the hole left by the Fed.
“There is no buyer of last resort right now,” said Christopher Maloney, a mortgage strategist at BOK Financial.
Other reasons like heightened volatility and uncertainty about the direction of interest rates also helped keep spreads wider. And a wave of refinancings in 2020 and 2021 when rates were ultra-low caused mortgage bonds to pay investors back faster than they were expecting, an annoyance they also dealt with by demanding higher spreads.
The Fed isn’t likely to come back to the mortgage market anytime soon, but other factors that keep spreads elevated do seem to be easing, said Rob Haworth, a senior investment strategist at U.S. Bank’s asset management group. Markets have reached a consensus about the direction of future Fed rate cuts — rates are expected to gradually continue easing — while higher mortgage rates have limited refinancing activity for now.
“We’re all kind of waiting for more normalization,” Haworth said.
Claire Boston is a senior reporter for Yahoo Finance covering housing, mortgages, and home insurance.
From: Yahoo.com
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