Homeowners have enjoyed rock-bottom mortgage rates for years now. But with the recent spike up in bond yields, mortgage rates have followed suit, climbing a full percentage point to about 4.5% for 30-year mortgages in just the past two months. Given the speed of the rate increase, concerned would-be homebuyers are wondering just how far mortgage rates could climb.
A recent column from financial analyst Richard Barrington asked how quickly rising mortgage rates could come, and he argues that 6% rates could be just a year away without anything more extraordinary than a return to more normal conditions in the credit markets. Let’s take a closer look at the arguments for and against continued rises in mortgage rates and the impact they could have on your finances.
Focusing on margins
One way to look at mortgage rates is from the perspective of the lenders that make mortgage loans. As Barrington notes, lenders have to pay special attention to the potential for future inflation because the long-term nature of mortgage loans can potentially leave them exposed to interest-rate risk for decades. Historically, when you look at the spreads that lenders have demanded over expected inflation rates over the past 40 years, you find mortgage rates that were typically almost 4.5 percentage points above the rate of inflation. Therefore, when you look at past inflation since 2008 that has averaged about 1.5%, you get a “standard” mortgage rate of 6% once those spreads get back to normal.
Interestingly, though, this analysis doesn’t mention an important factor: Increasingly over the past decade, major mortgage lenders haven’t held onto their loans but rather have sold them on to government-sponsored enterprises Federal National Mortgage Association (OTCBB:FNMA) and FREDDIE MAC PFD Z (OTCBB:FMCKJ). During the housing boom, mortgage lenders Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) didn’t perform as well as they did because they were securing particularly high margins on their mortgage loans. Rather, they collected transaction-based income by immediately reselling conforming loans to Federal National Mortgage Association (OTCBB:FNMA) and FREDDIE MAC PFD Z (OTCBB:FMCKJ), often retaining streams of income from risk-free mortgage-servicing rights without keeping any liability for potential loan default. Even now, Wells Fargo & Co (NYSE:WFC) relies on strength in mortgage-related income, and decreases in refinancing activity pose a threat to income growth in future quarters — although unlike many of its peers, Wells has actually retained a good portion of its loans on its own books.