Mar 15, 2020

I've wanted to write to you all week to explain what is going on with the financial markets and mortgage interest rates.  But things were changing so quickly, I realized I'd have to wait for the weekend when the markets were closed.  Otherwise, by the time I finished writing, everything would have changed.  Thanks, Feds, for meeting on Sunday, and totally screwing with my plan.

We started last week with the lowest mortgage rates in history.  By the end of the week, most rates had risen 0.5% to 0.625%.  And I have whiplash from trying to follow the stock market.

What the heck is going on?

Usually, a bad day for the stock market equals a good day for mortgage interest rates.  And last Monday was a terrible day for the stock market.  Stocks are considered risky investments (albeit with the potential for high returns).  When the stock market is doing poorly, investors pull their money and invest in safer investments like mortgage bonds.  So usually when the stock market is down, bond markets are up, and mortgage interest rates decline.  That's what happened on Monday.

Then all hell broke loose.  As coronavirus cases surged around the world, investors pulled their money out of everything.  The stock market was down, bonds were down, mortgage backed securities plummeted.  People bailed out of stocks, bonds, and gold all at the same time in favor of toilet paper and cash.

Then on Thursday, the Feds injected liquidity into the market.  What does that mean?

If you need cash, what do you do?  You go to the bank and withdraw money out of your bank account.  But what happens if everybody is trying to get cash out of the bank at the same time?  The bank might not have it.  They may have given your money to someone else.

According to the Federal Reserve Act, the bank only has to hold onto 10% of the deposits they get from you.  They can loan out the other 90% to make money.  A deposit is a liability to a bank.  The bank has to pay you interest on that deposit.  So they take 90% of your money (on which they are paying you a small amount of interest), loan it to someone else at a higher interest rate, and earn a profit.  That's how banks make money.

But if everyone wants their cash at the same time and the bank doesn't have it, what do they do?  They borrow it from another bank.  And usually the other bank has the money they can lend to the first bank.

But they don't just lend the first bank money because they're nice.  Instead, the first bank puts up assets in what's called a repo market.  They post assets as collateral, the second bank holds those assets, and when the first bank repays the money they borrowed, they get their assets back.

And it usually works out just fine.  But what happens if there's a run on all the banks?  Maybe the second bank doesn't have the money either.  Then the system begins to break down.

To complicate matters further, in addition to the Federal Reserve Act, banks have to comply with Dodd Frank.  And Dodd Frank has a collateral reserve requirement.  So the second bank may be perfectly willing to loan money to the first bank.  They may have cash sitting there.  But they might be unable to loan it out because of the Dodd Frank collateral reserve requirements.

Enter the Feds.  They fix the problem by buying the first bank's assets.  Then nobody has to worry about liquidity.  That's what the Feds did on Thursday.  They announced that they would dramatically increase liquidity by injecting as much as $1.5 trillion into asset purchases.

At first, the market took this as great news and went nuts.  But it didn't take long to figure out it wasn't the greatest thing since sliced bread.  The stock market sold off and ended up at exactly the same level it was before the announcement, in all of 15 minutes.

Friday, stocks ended the day considerably higher.  The president declared a national emergency and announced steps the government will take to provide relief and stimulate the economy.  He mentioned freeing up $50 billion in financial resources and freezing interest on federal student loans.

Then on Sunday, the Feds held an emergency meeting, slashed its benchmark interest rate to 0% to 0.25% and re-launched quantitative easing, pledging to buy $700 billion of treasuries and mortgage backed securities.

To be clear, YOUR interest rate will not be 0%.  Nobody is getting a 0% mortgage.

Remember, the Federal Reserve adjusts short-term interest rates.  Mortgage interest rates fluctuate based on long-term bond rates.  I've talked about it before.

When the Federal Open Market Committee "lowers interest rates," they are decreasing the federal funds rate, the interest rate at which a bank lends funds maintained at the Federal Reserve to another bank overnight.

The higher the federal funds rate, the more expensive it is to borrow money. The federal funds rate is considered the base rate that determines many other interest rates and indices in the US economy. For example, when the federal funds rate decreases, the prime rate decreases. And the prime rate determines interest rates on things like credit cards and home equity lines of credit.

But the prime rate is a short-term index. Mortgages are more sensitive to the bond market and yields on US Treasury notes. Mortgage interest rates may decrease in anticipation of the Feds decreasing rates. But they often increase following a Fed decrease.

What affect will all this have on mortgage interest rates?  That's a very good question.

While the Feds don't directly control long term interest rates, quantitative easing should theoretically drive rates lower.  QE is a monetary policy in which the government buys government bonds and other securities.  It actually increases the supply of money and lowers the cost of money which translates into lower interest rates.

That being said, many lenders aren't offering mortgage interest rates consistent with the market.  A cursory Internet search shows interest rates that are all over the map. reveals 30-year fixed rates from 3.875% to 5.875% for a refinance with no discount points.  That's a huge range!

Why the difference?

Lenders can't handle the volume and they're actually trying to slow down business.  The Mortgage Banker's Association reported last Wednesday that mortgage application volume was up 55.4% the previous week.  Purchase applications were up 6% over the week prior and up 12% year-over-year.  Refinances rose to the highest level in 11 years, up 79% over the previous week and 479% year-over-year.  In short, lenders have more business than they can handle so they are artificially keeping interest rates higher than the market demands to discourage additional applications.

Lenders also face pressure to hedge interest rates.  Rates are extremely volatile right now.  If yields on bonds increase between the time a borrower locks their interest rate and the time they close their loan, it makes that loan difficult to sell on the secondary market.

The bottom line:  The economy is slowing and a recession is all but inevitable.  Until things stabilize and the coronavirus is under control, we are going to be in a very volatile environment.

Things are happening quickly right now.  I believe we will see interest rates decline again once lenders have worked through their capacity issues and the market settles.  I don't know if we'll get exactly where we were last Monday, but I think we'll get close.  It just might take some time.

So what do you do if you're a homeowner and you want to refinance?

  • Be patient.  Your loan officer is probably a little overwhelmed and is processing requests as quickly as they can.
  • Complete your application, provide the paperwork required, and acknowledge your disclosures.  When interest rates decline again, your loan officer may only have a window of a few hours to lock dozens of applications.  Your loan officer will not have time to call you and process your application during that window.  If you're not already in the computer system and ready to lock, you will have to wait for the next round.
  • Work with a local lender who understands all this mayhem and constantly monitors the market.  Many loan officers lock loans when they receive applications.  I constantly read commentary on social media from loan officers who say they always lock immediately because they couldn't sleep at night with a large floating pipeline.  Frankly, I believe it's my job to float your loan until I can get you the best interest rate for market conditions.  If I had trouble sleeping at night, I'd look for a new job.

What if you want to purchase a home?  Make sure you're working with a lender who prioritizes purchase transactions.  Here's what we're doing:

  • We improved our pricing on purchase transactions by 0.25%.  We are committed to providing a world-class lending experience for our customers and referral partners.
  • We loosened underwriting policies for refinances where we could and identified processes that could be completed by processors instead of underwriters.  This frees up our underwriters' time to focus on purchases.
  • We're offering free float-downs when it's appropriate.  If interest rates decline significantly after a loan is locked, we're offering customers the new lower rates.  It's the right thing to do.

It's definitely NOT a boring time to work in the mortgage industry (or any financial services industry, for that matter).  And it's a great time if you happen to own a home with a mortgage or you want to buy a home with a mortgage.  Just don't look at your 401(k) for a while.

Stay safe out there.  And don't forget to wash your hands!