The 10 Year Treasury Yield is 3.46%, as I am typing this blog. The average 30-Year Mortgage Rate is 6.21%, per Mortgage News Daily.
That is a spread of 2.75%.
What makes that so interesting is the fact that prior to 2022, the spread between the 10 Year and Average Mortgage Rates was about 1.7%, per this article by Zonda’s Chief Economist.
Even though we send all of our pre-approved borrowers regular updates with respect to mortgage rates, they often ask us how they can follow the interest rate market in general.
And – we used to tell those borrowers to follow 10 Year Treasury Yields, as mortgage rates closely track or correlate to 10 Year Treasury Yields.
When 10 Year Yields are up, so are mortgage rates – and vice versa.
But over the last 12 months, we saw the 10 Year Yield and mortgage rates move in opposite directions on occasion, and we saw the spread between the two increase by over 1%.
Note: 10 Year Treasury Yields are always much lower than the average 30-year mortgage rate because 10 Year Treasuries have no risk of default are safer investments) and because they have no risk of early payoff like mortgages do (from selling or refinancing).
Per the Zonda Chief Economist I link to above, the spread between mortgages and 10 Year Treasuries widened for a few reasons: (1) the Fed stopped Quantitative Easing or buying mortgage-backed securities (MBS), significantly reducing overall demand and pushing mortgage rates up; and (2) investors started to see mortgages as riskier bets in an uncertain economic environment, and thus demanded higher yields.
Macro Analyst Jeff Snider would likely differ though, as he likes to remind us that the Fed’s Quantitative Easing does not impact interest rates nearly as much as people think, and uncertain times increase the demand for 10 Year Treasuries for a variety of reasons, pushing yields lower (so, it is not that investors see MBS as riskier bets so much as it is investors just demanding 10 Year Treasuries a lot more).
Both the Zonda economist and Snider are no doubt partially right, but enter Barry Habib (who probably understands the mortgage market better than anyone).
Barry says the primary reason the spread has widened is because the value of Mortgage Servicing Rights or MSRs has fallen sharply.
(stay with me here, as this is where it gets interesting – and this is the GREAT NEWS!)
Mortgage banks make their profits by selling their loans for a “premium,” as most people know. For example, if we lock a $500,000 loan and charge no points or origination fees, we make our money by selling that loan to an investor for say $510,000 soon after the loan funds.
But – many mortgage banks also sell the Mortgage Servicing Rights (MSRs) along with those loans. Investors or servicers want those MSRs because they can get a constant income stream, as they can charge lenders/noteholders 0.25% to 0.5% of the remaining principal balance (loan amount) for servicing (to collect payments, to manage impounds, and to do all of the accounting).
Anyway, a big chunk of a mortgage bank’s profits can come from selling MSRs, and right now MSRs are worth a lot less because so many investors expect the current crop of mortgages to pay off very soon because so many investors expect rates to fall sharply and soon (incentivizing borrowers to refinance).
And THAT IS THE GREAT NEWS! The people with the most knowledge and skin in the game are convinced rates will fall soon. So, it is not just Snider and Habib who think rates will fall – it is every investor that buys MSRs.
No investor will want to pay $5,000 for servicing rights, for example, if she thinks the loan will pay off long before she collects enough servicing fees to make up that $5,000.
In contrast, if rates are extremely low, investors will willingly pay a steep price for MSRs because those loans are much less likely to pay off – so the owner of the MSRs will be collecting fees for a long time.
Anyway – I hope this was educational, and I hope everyone is now as convinced as I am that rates will fall this year.
Jay Voorhees
Founder | JVM Lending
(855) 855-4491 | DRE# 1197176, NMLS# 310167
