The Federal Reserve’s half a percentage point rate cut and the accompanying dive in long-term bond yields will drive mortgage rates to “unimaginable” lows, setting the stage for a record wave of refinancing that will put billions of dollars into Americans’ pockets.
“If we are at or below 1 per cent on the 10-year Treasury, we are going to be at record-low mortgage rates, and we are going to see record demand” for refinancing, said Michael Fratantoni, chief economist of the Mortgage Bankers Association.
Ten-year treasuries were yielding 0.99 per cent as of Tuesday’s close.
Mortgage rates were already at historic lows when the Fed announced its emergency cuts on Tuesday. Average 30-year fixed mortgage rate in the US hit 3.45 per cent in February, according to mortgage insurer Freddie Mac, the lowest level since 2016 and close to the all-time lows of 3.31 per cent hit in late 2012.
The MBA’s index of refinancing activity also hit a six-year high in January, and remains near all-time highs. The MBA estimates there was $323bn in refinancings in the fourth quarter of last year.
The yield on 10-year bonds has fallen by more than half a percentage point in the past two weeks, including a 16 basis point sell-off on Tuesday. If mortgage rates ultimately capture all of that decline, the impact on household budgets could be significant.
On a $300,000 mortgage — the average refinancing size in recent months — the difference in annual payments between a 3.5 per cent and a 3 per cent 30-year mortgage is almost $1,000. Refinancing fees can come a multiple of that, but those are generally rolled into the new loan balance, effectively spreading them over the life of the loan.
The effect on mortgage demand from the recent rate declines should be “instantaneous”, said Lawrence Yun, chief economist for the National Association of Realtors. “Investors are very sensitive to mortgage rate changes . . . people will check into the market next week,” he said, given the “unimaginably low” mortgage rates he anticipates.
Because most mortgage loans are ultimately packaged into tradeable securities, banks’ balance sheet capacity does not constrain mortgage refinancing rates. Banks’ ability to process customer requests can keep mortgage rates high while lenders ramp up capacity.
“Lenders are scrambling to meet demand,” said Mr Fratantoni. He thinks the adjustment in rates “will be a couple of months’ process, to get the pig through the snake”.
Mr Yun argued that “for the broader economy and home prices, this will be a good countermeasure to coronavirus’ . . . economic fallout”, but other analysts said the stimulus effect depended on a number of factors.
Danielle DiMartino Booth of Quill Intelligence, a research firm, said the Fed’s emergency cuts “definitely brings mortgage rates down, but keep in mind that we are in a demand shock so lowering rates can only do so much”. Consumers have to be willing to go to “automobile floors, conferences, vacations, restaurants, movies”, she said. “In the longer term, you will have more cash in your pocket but it could get drowned out by this demand shock.”
The banking industry will not, however, receive a stimulus from the coming refinancing wave. Revenues from refinancing mortgages and selling them into the bond market now account for only 2 per cent in US banks’ revenues, according to Autonomous Research. At almost all banks, this means that the fillip from refinancing will be overwhelmed by the negative effect of falling rates on mortgage yields. Bank indices have fallen 15 per cent in recent weeks.
“The rate impact on banks is material and that is being priced in recent weeks in the stock markets,” said Aaron Deer, bank analyst at Piper Sandler. “It’s not a positive.”