Are you Crazy?

Mortgage rates hit another historic low the past week. A thirty year fixed rate could be had right at 4% and a fifteen year rate was at 3.375%. All the talking heads are emphasizing the opportunity to refinance and the public has rushed to their nearest mortgage lender. It's all good.

If you look at the math rates should be even lower and there are some very good reasons why they probably won't get there.

Who Sets the Rates, Anyway?

We have written here earlier about how mortgages are made into bonds as Mortgage Backed Securities. Once they become bonds they are traded on a constant basis just like any commodity or stock. There are general patterns of money movement that affects them. Usually when the stock market goes down cash runs into bonds and rates go down. When stocks go up rates usually go up as well.

Analysts also look at trends especially relative to future possibilities of inflation. The perceived future rate of inflation is factored into the "spread" to protect the investor's investment in a changing environment.

The spread can be viewed as a profit margin. Prior to the creation of the secondary market, a bank would look at their cost of money and add a profit margin to that cost.That would set the level of interest rate they would lend money at. That basic relation is still in effect based upon the Fed Funds Rate and other rate indexes like the 10 year Treasury bond.

If you look at these rates and the rate of inflation (or non inflation) the current 30 year rate should be in the neighborhood of 3.5%. A 15 year rate could be as low as 2.5%. But there has been extrmemly high resistance at the 4% and 3.5% levels respectively. There is normally about a 1% difference between a 30 year and 15 year rate. Currently that is closer to .5%.

So what's going on.

Liquidity is based upon comfort not fear.

Without getting too technical, let me just say that bonds come in .5% increments. There is a 3%, 3.5%, 4% and 4.5% bond. All other rates are sold into these bonds with calculated price adjustments. In order to have rates in the low 3's you have to have a market in 3% bonds. That market is dry right now.

The large market makers, as you might guess, are the companies that already have trillions of dollars of mortgages that are on their balance sheets and providing their cash flow. If they don't play or they work in the opposite direction, a market will not become liquid and a rate will not be available.

The guide for a refinance is that you should improve your rate by 1%. So today any 30 year loan should be evaluated if the rate is over 5%. Until recently, that number was 5.5%. If rates dropped to the "math level" anything over 4.5% would be at risk for an owner of the bond.

The amount of loans over 5.5% compared to those over 4.5% is literally trillions of dollars at work that would disappear from balance sheets. In addition the number of loans originated in the last two years in that category is also trillions of dollars. The expense of originating those loans has not been recaptured yet from the income of servicing those loans.

So I'm not sure why math has not driven interest rates lower..... but I'm kinda thinkin ......

Mortgage rates hit another historic low the past week. A thirty year fixed rate could be had right at 4% and a fifteen year rate was at 3.375%. All the talking heads are emphasizing the opportunity to refinance and the public has rushed to their nearest mortgage lender. It's all good.

If you look at the math rates should be even lower and there are some very good reasons why they probably won't get there.

Who Sets the Rates, Anyway?

We have written here earlier about how mortgages are made into bonds as Mortgage Backed Securities. Once they become bonds they are traded on a constant basis just like any commodity or stock. There are general patterns of money movement that affects them. Usually when the stock market goes down cash runs into bonds and rates go down. When stocks go up rates usually go up as well.

Analysts also look at trends especially relative to future possibilities of inflation. The perceived future rate of inflation is factored into the "spread" to protect the investor's investment in a changing environment.

The spread can be viewed as a profit margin. Prior to the creation of the secondary market, a bank would look at their cost of money and add a profit margin to that cost. That would set the level of interest rate they would lend money at. That basic relation is still in effect based upon the Fed Funds Rate and other rates indexes like the 10 year Treasury bond.

If you look at these rates and the rate of inflation (or non-inflation) the current 30 year rate should be in the neighborhood of 3.5%. A 15 year rate could be as low as 2.5%. But there has been extremely high resistance at the 4% and 3.5% levels respectively. There is normally about a 1% difference between a 30 year and 15 year rate. Currently that is closer to .5%.

So what's going on?

Liquidity is based upon comfort not fear.

Without getting too technical, let me just say that bonds come in .5% increments. There is a 3%, 3.5%, 4% and 4.5% bond. All other rates are sold into these bonds with calculated price adjustments. In order to have rates in the low 3's you have to have a market in 3% bonds. That market is dry right now.

The large market makers, as you might guess, are the companies that already have billions of dollars of mortgages that are on their balance sheets and providing their cash flow. If they don't play or they work in the opposite direction, a market will not become liquid and a rate will not be available.

The guide for a refinance is that you should improve your rate by 1%. So today any 30 year loan should be evaluated if the rate is over 5%. Until recently, that number was 5.5%. If rates dropped to the "math level" anything over 4.5% would be at risk for an owner of the bond.

The amount of loans over 5.5% compared to those over 4.5% is literally trillions of dollars at work that would disappear from balance sheets. In addition the number of loans originated in the last two years in that category is also trillions of dollars. The expense of originating those loans has not been recaptured yet from the income of servicing those loans.

So I'm not sure why math has not driven interest rates lower..... but I'm kinda thinkin ......