I Can’t Read Tea Leaves Either: Chapter 2
At the fundamental level of what mortgage rates should be, the rule of thumb has typically been to add 1.5-2% to the 10 year treasury rate and boom, there’s your mortgage rate. For the last few years, however, nothing has been typical, and the factors at play have caused more variation between the 10 year and mortgage rates, first with a significantly lower yield and then with a significantly higher yield versus historical averages.
If you ever catch me anxiously looking at a weird set of numbers on my phone, I’m not checking my automated text alerts for the treasury bond, though: I’m checking mortgage backed security prices. Abbreviated as MBS, these are the pooled groups of mortgages that have been grouped into a security that is bought and sold by investors. Fannie Mae and Freddie Mac play the role of turning individual mortgages into these pooled securities, which spreads the risk of an individual default across the group and makes the net investment a lower risk.
We know why investors would want to buy mortgage rates as compared to the treasury now: they pay more, and if the amount of “more” is sufficient to correspond with the expected risk, investors want to buy MBS to make more money. Like any other product, though, there is a supply and demand component.
Mortgage Rates vs MBS price
If many investors want to buy a finite number of mortgages being sold in mortgage backed securities, the price goes up because they are willing to pay more to have their money allocated to that investment. If investors are willing to pay more up front to obtain a mortgage, they have a higher cost for entry, so to speak. When MBS prices go up because there is strong demand, mortgage rates go down, because the demand indicates investors will still purchase the loans at a lower rate since they have indicated willingness to pay more to hold those loans.
Higher demand for MBS drives prices up, which means rates can go down and investors will still buy the loans. Tracking the trading prices of MBS is the quickest and most accurate way that I have found to predict rate movements in the very short term. Since lenders are generally locking an interest rate for 30 days and their loans will likely be sold in 45-60 days, pricing offered to the borrower is very sensitive to anticipated demand for that loan at that rate, and if there’s low demand, lenders will quickly increase rates to make sure they aren’t holding a loan in 2 months that no one wants. Alternatively, when there is strong demand, lenders will decrease rates offered to the consumer to ensure that they have loans available to sell and pool in anticipation of strong demand.
