Mortgage rates pushed to a fresh two-decade high this week, making it tougher for the housing market to emerge from its stark slowdown.
The average 30-year fixed mortgage came with an interest rate of 7.23%, according to data published Thursday by Freddie Mac. Some borrowers are paying even loftier rates. The rate was 7.09% a week ago, its first time above 7% since last fall.
The new high is a turnabout from two years earlier, when borrowing rates were below 3%, near record lows. Millions of people were rushing to buy homes and refinance. Now, financing a typical home purchase costs hundreds of thousands of dollars more in interest.
Applications for purchase mortgages dropped to their lowest levels since 1995, the Mortgage Bankers Association said this week. Existing-home sales fell for the fourth time in five months in July.
“The conveyor belt of houses that come on and off the market is just grinding to a halt,” said Sam Khater, chief economist at Freddie Mac.
Mortgage rates, which rose for most of last year, resumed their upswing in recent months when the Federal Reserve signaled it is in no rush to loosen monetary policy. The economy has stayed strong in the era of higher rates, meaning the central bank may keep rates high or lift them further to hold inflation in check.
Mortgage rates tend to loosely follow the yield on the benchmark 10-year Treasury note, which also hit multiyear highs this summer. But mortgage rates have risen far more than government bond yields recently.
They have been about 1.75 percentage points higher than the going Treasury yield on average over the past half-century, but in the past year they have been almost 3 percentage points higher, according to Urban Institute data.
The differential has recently been about as large as it was during the financial crisis of 2008, according to the Brookings Institution.
That spread, as it is called in industry parlance, is created by a few components. The biggest thing to understand is that lenders don’t usually hold on to the mortgages they make; instead they look for investors to buy them.
That comes at a price, though. Investors want to earn more for taking on the risk of buying mortgages compared with super-safe Treasuries. Lenders also have to cover their own costs of making the loan.
There is a lot of uncertainty about the economy and interest rates right now, which means that investors are demanding higher yields to compensate for it.
“If there’s more volatility in interest rates, there’s less certainty that I’m going to benefit here, so I end up pricing that in,” said Michael Neal, principal research associate at the Urban Institute’s Housing Finance Policy Center.
There is also less demand from key investors for mortgages. The Fed, which purchased massive amounts of mortgage bonds during the pandemic as part of its effort to stimulate the economy, has bought virtually none over the past year because it is shrinking its portfolio.
Banks, which also plowed their extra cash into mortgage bonds when rates were low, are now trimming their holdings, wary of holding long-duration securities on their balance sheet. Silicon Valley Bank had a big portfolio of mortgage bonds, which hastened its demise in March.
Mortgage-related security holdings by banks and credit unions fell 7% from a year earlier in the first quarter, according to Inside Mortgage Finance data. Regulators started to liquidate tens of billions of dollars in mortgage-backed securities from SVB and Signature Bank in the second quarter, adding to supply.
Other opportunistic players have stepped in. Investors are after yields of over 6% on newly originated mortgage-backed securities, compared with around 4.5% a year ago and less than 2% two years ago, according to Mark Tecotzky, vice chairman and head of credit strategies at Connecticut-based Ellington Management Group.
“You’re starting off at the 50-yard line,” said Tecotzky, who is co-CIO for Ellington’s public real-estate investment trusts. “There’s a lot more yield in the market.”
The wider spread directly feeds into higher rates for people taking out mortgages. Would-be buyers are shelving purchase plans because homes are so unaffordable. Would-be sellers are on the sidelines because they don’t want to lose their low rates.
Emily and Caleb Erbert have paused their home search in the Detroit suburbs. They were recently quoted mortgage rates above 8%, far higher than the rate of just over 2% on their current home, she said. They hope rates will fall by early next year.
For the moment, the family of four are making due in the house they have outgrown. They plan to convert a room in the basement into an office for Caleb so that their seven-month-old can have his own room.
“We’re constantly having to tiptoe around when the kids are sleeping,” Emily Erbert said. “We’re just kind of limping along until things get better.”
At Gateway First Bank in Tulsa, Okla., residential mortgage volumes slumped by more than a third from a year earlier in July, according to Steven R. Plaisance, president of mortgage banking.
“This is the worst market I’ve been in, all things considered,” said Plaisance, who got into the mortgage business in 1991.
Still, if the gap between Treasury yields and mortgage rates were to shrink back to its historical level, that could provide a substantial drop in rates that brings out purchasers and people needing to refinance. Mortgage companies are hopeful that could drum up business.
“It really could be any day right now that the rates could drop and it doesn’t need some crazy thing to happen,” said Mat Ishbia, CEO of UWM Holdings, the largest U.S. mortgage lender, on an earnings call this month. “It just means those spreads come back to normalized numbers.”