In spite of concerns about mortgage demand shrinking in 2019, we will probably see a rise in the 30-year fixed mortgage rate this year, even though it will be fairly modest.
There is a lot of talk these days about stagnant bond yields casting a net of uncertainty over the mortgage and housing market in the coming year. In order to get a good picture of this though, we need to take a close look at several factors which influence this, and bonds are certainly one of them.
Bonds compete with mortgages in the marketplace, to the extent that mortgage rates and bonds tend to move together. It’s not that people looking for a mortgage are going to ever consider bonds as an alternative, and buying bonds involves lending money the same way that mortgages do, so this dynamic occurs on the sell side of mortgages, a market that bonds do compete in pretty significantly.
If we imagine that there is a pool of money out there with lenders, who could lend you money for a mortgage or lend it out through other sources, such as buying bonds. Mortgages are considerably riskier than, say, 10-year U.S. treasury bonds, which are actually deemed to be risk free.
There is a risk even with U.S. treasuries, but when we look at the risk of the U.S. government defaulting on them over a 10-year period we’ll say, this risk is virtually meaningless because it is so low, and is therefore treated that way by the market.
In the aggregate, we always see a certain default rate with mortgages, and just because the lender has a lien on your home doesn’t mean that they escape these defaults without losses. Lenders are not real estate speculators and value time quite highly here, and foreclosure sales therefore involve sellers accepting less than market value for the property typically and just getting the deal done as soon as possible.
Mortgage insurance helps a lot here, and prior to this, lenders wouldn’t even lend without a large down payment, in order to minimize their potential losses if the loan ends up going bad. Overall though, foreclosures on properties are not something lenders welcome and they work hard to avoid being put in these situations because defaults are not favorable to them. At best, they get most of their money back but give up the income stream that a good mortgage, or something like bond investments would have provided them instead.
It Is All About the Spread
We then see a spread between the 30-year fixed rate and a risk-free investment such as 10-year treasuries, which functions as the risk premium. This risk premium may fluctuate depending on the lending market, but given a certain premium, movements of these risk-free bonds will cause mortgage rates to move in tandem with them generally.
There’s a practical side to this equation as well, as lenders do lend money out to bondholders such as the U.S. government in addition to lending out money to buy or to refinance property. Banks just don’t lend all their money out in loans, and actually hold trillions of dollars’ worth of risk-free bonds at any given time. Bonds definitely compete with other forms of lending at this level.
Bond rates aren’t exactly stagnant right now, at least if we mean by this that prices not fluctuating too much, as we’ve certainly seen some movement with them of late. Between November 8 and January 3, we’ve seen the 10-year move from 3.24% down to 2.56%, and since then move up to its current 2.74%.
An example of relatively stagnant bond rates would be what we saw last summer, where during the months of June, July, and August, we stayed in the high 2’s, before we saw them rise to the aforementioned 3.24% and then drop as the year wound down.
If we’re wondering where mortgage rates may be headed in 2019, looking at things like the housing market doesn’t particularly shed a lot of light. Mortgage rates are set more by opportunity cost, what lenders could do with the money instead, rather than demand, although demand does certainly matter a lot with things like profitability.
To add to all this, bond yields are closely correlated with inflation, not just current levels but predicted future levels as well, and income net of inflation is what really matters when it comes to the bottom line of lenders.
While individuals generally don’t time their purchases or refinances all that much with the rate market, and rarely will set aside their needs based upon rate forecasts, this does affect decisions on whether to go with fixed or variable rates.
Bonds only really influence fixed mortgage rates, and the reason is that while all mortgages involve risk, variable rate ones are mostly concerned with default risk, where with a fixed rate mortgage we’re adding in additional rate risk to the equation for them.
The View is That We May Expect Higher Rates in 2019
The consensus these days is that both bond rates and fixed mortgage rates are expected to rise in 2019, but analysts differ as far as the extent of this rise, as they often do. The 30-year fixed is averaging 4.45% these days, which by the way is well below its historical average.
The belief is that we’ll be moving up towards 5% or perhaps even higher during 2019. Fannie Mae has us only going to 4.8%, Wells Fargo has this pegged at 4.9%, Moody’s is predicting 5%, Freddy Mac and the Mortgage Banking Association agree on 5.1%, with Realtor.com analysts seeing us go all the way to 5.3%.
As far as the 10-year treasury goes, we’re seeing views emerge that are more conservative. Analysts are viewing the current economic slowdown as limiting to the treasury market and generally view the November numbers as peaks, and while the expectation is that rates may go up a little, any rally is expected to be fairly muted.
This suggests that the lower end of the 30-year fixed predictions may be more likely to happen, but this still has us looking at the 5% area right now. That’s a modest increase but nothing that should produce too much concern for those looking for a mortgage in 2019.