Why Home Mortgage Rates Are High Relative To Treasuries—And When They Will Fall
The interest rate on home mortgages is currently higher than the interest rate on long-term treasury bonds. The average spread over all available data before the pandemic was 1.69 percentage points. This means that the cost of the average 30-year fixed rate mortgage was 1.69% higher than the interest rate on a 10-year treasury bond. However, the spread is currently wider than the long-term average and ranges between 1.5% and 2.0%.
The reason for the high mortgage rates in comparison to treasuries can be attributed to several factors. When a homebuyer goes to a mortgage originator, they are quoted an interest rate, and the originator sells the loan to a government-sponsored entity like Fannie Mae or Freddie Mac. The mortgage originator is paid a cash equivalent to the value of pushing the interest rate up. This payment can be thought of as the retail mortgage spread. When Fannie or Freddie sells a bundle of mortgages to investors, the interest rate is based on supply and demand, and investors generally view mortgages as inferior products compared to treasury bonds.
Although the spread is currently wide, it is likely to return to normal, meaning lower mortgage rates as long as treasury interest rates remain stable. However, this is not expected to happen in 2023. The potential decline in mortgage rates will depend on various factors, including economic conditions and government policy changes. Investors’ reluctance to buy mortgages with high interest rates or low-interest rates that cannot be refinanced creates challenges for the market. Nevertheless, understanding the factors that contribute to high mortgage rates compared to treasuries can help predict when they may fall.
The wide spread between home mortgage rates and treasury bond interest rates is due to the wholesale mortgage spread, which is the premium that investors demand for mortgage-backed securities compared to treasury bonds. This is because the option for homeowners to refinance their mortgages makes mortgage-backed securities a less attractive investment option. The total spread is the sum of the retail spread, which is the profit margin for mortgage originators, and the wholesale spread. The wide total spread in early 2023 seems to be due to the wholesale level, with bond traders citing volatility of interest rates as the key factor.
The wide spread is expected to return to normal, which is the historical average of 1.69%, but not in 2023. The key factor for the spread to return to normal will be when interest rates stabilize after the Federal Reserve has finished its tightening and then eased back to a stable path for future interest rates. As of March 2023, it looks like more tightening is in store, and the Fed is expected to drop rates to get the economy going again, possibly in 2024. Once they get rates to a level that can continue for years, the spread will narrow, and mortgage rates will gradually decline, adding more downward pressure to mortgage rates.
For prospective home buyers and new homeowners looking to refinance, the actual mortgage rate will fall when the Fed starts easing, or possibly earlier in anticipation of that easing. Mortgage rates would fall even if the spread remains wide, and the narrowing of the spread, when it occurs, will add more downward pressure to mortgage rates.