04/01/2020
PSA: If you are thinking about taking a vacation from paying your mortgage and don't really need to I would advise against. Rates will drop when we see the light at the end of this awful tunnel and when they do if you participate in mortgage forgiveness you will be ineligible to refinance for one year. Just food for thought. Obviously if you need to use it to protect your family by all means use it. One of the most common questions I get from the people I speak to on a daily basis ask why mortgage rates are not lower. Below is a great summation of the why and how of where we are now;
mortgage impact
February 2020, as the coronavirus continued to spread rapidly, investors began rebalancing their portfolios to less risky assets such as treasuries, bonds and mortgage backed securities (MBS).
This helped mortgage rates drop briefly to some of the lowest rates in history which caused a tidal wave of refinance applications.
supply shortage
Based on supply and demand, the demand for refinance loans was higher than the supply of mortgage capacity at lenders and banks.
Just like toilet paper disappearing off store shelves due to high demand, low mortgage rates disappeared as lenders raised rates to slow applications.
Rate whiplash
As banks and lenders funded billions of dollars in mortgages to sell as Mortgage Backed Securities (MBS), others also rapidly sold these assets to raise capital which caused the secondary markets to become flooded.
The oversupply of MBS meant buyers were not purchasing the assets as quickly as they hit the market which sent the the price of MBS coupons plummeting.
The drop off in MBS value caused mortgage rates to spike 1-2% in rate within a few days!
social distancing
As the government began issuing social distancing orders, businesses were forced to close, laying off millions of workers.
The fear of illness turned into a major economic concern as analysts realized that homeowners without jobs may not be able to pay their mortgage payments.
feds to the rescue
The Federal Reserve began to see the economic impact caused by social distancing and the closure of businesses.
To lower the risks of a major long term recession, an emergency meeting was held where they dropped the Fed Funds Rate to near zero percent.
The Federal Funds Rate is the overnight borrowing rate between banks which is used to cover depositor withdrawals and other obligations.
News outlets reported that rates were at 0% but did not explain that this is not mortgage rates which had actually jumped up.
Homeowners began frantically calling mortgage companies to refinance, mistakenly thinking that mortgage rates had hit zero.
mortgage servicers
As refinance applications jumped, mortgage servicers began to panic.
Once a loan is closed, a servicer buys mortgage servicing rights (MSR) which is the ability to collect payments and pass them on to the end investor. They then receive a fee for servicing the loans.
They need 3-4 years of collecting payments to break even on their purchase of servicing rights. If clients refinance, there are major losses for servicers. The potential for early payoff losses dropped the value of mortgage servicing.
Feds "help" More
Mortgage rates are not set by the Feds. They are priced by several factors including the value of Mortgage Backed Securities (MBS) and Mortgage Servicing Rights (MSR).
As a flood of refinancing hit, the value of MBS and MSR dropped at unprecedented rates. When the value of holding mortgages drops, mortgage rates jump up rapidly.
High mortgage rates in a slow economy would be disastrous. To attempt to drive down mortgage rates, the Feds announced a bailout package which included the daily purchase of billions in mortgage backed securities.
HOT poTATO
With the Feds buying billions of MBS at levels never seen before, the MBS value began to come back up, which in theory, should drop mortgage rates.
The problem is that the Fed's plan overlooks the unintended consequences to mortgage lenders and mortgage servicers. If rates drop too rapidly, they lose a significant amount of money.
Lenders have major costs from hedging the markets to lend and have to contribute huge sums of capital which may need to be borrowed at high rates. Lenders then have to pass these extra costs on in the form of higher mortgage rates.
Mortgage servicers lose value as MSR values drop. Mark-to-market accounting slashes their asset value which affects their ability to access additional capital they need to stay in business.
The Feds bailout packages do not address the fact that mortgage servicers are required to pass payments on to investors even if they do not receive payments from the borrowers. They may be obligated to billions of dollars in payments that they did not receive.
Ultimately, the government has created an environment where mortgages have become a hot potato. The ones left holding it could end up with significant losses or even bankrupt.
tightening Guidelines
In the face of economic slow down, Congress has also gotten involved with fiscal policy in "helping" homeowners with their mortgages. Before systems and plans were finalized, several people in power encouraged homeowners to call their mortgage company to skip their mortgage payments deepening the problem.
With this high potential for default risk, the mortgage industry has reverted to tactics we saw in the 2008 housing collapse. Banks and lenders began tightening guidelines, adding lending overlays, and discontinuing products.
The Non QM (portfolio loan) market has collapsed which has already closed the doors of several companies.
Jumbo loans have become increasingly difficult to obtain and may require larger down payments.
The farthest reaching changes are for Ginnie Mae, government backed mortgages including FHA, VA and USDA loans. These loans are designed to help lower score and low down payment borrowers.
The perfect Storm
The coronavirus has caused the perfect storm for mortgage markets. The combination of market volatility and unintended consequences from the government has left mortgage lenders and servicers reeling.
Until the storms calm and the coronavirus is better controlled, we will continue to see more restrictions on loans and less people qualifying for mortgages.
light on other side
Once the financial markets begin to recover, many economists believe that there will be a rapid bounce back.
Before the coronavirus hit, the underlying economy and housing market was very strong. Businesses were thriving with historically low unemployment.
The government will need to inject cash into consumers hands to stimulate the economy and promote growth. To do this, they will continue buying MBS which should keep long term mortgage rates low.
The US Treasury Secretary and Ginnie Mae have begun working on solutions for the short term liquidity issues of lenders and servicers which will calm market volatility in weeks ahead.
For now, let's all pray for a treatment and cure for the coronavirus and do our part to slow the spread by social distancing.
Written by Anthony Bird
