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Mortgage Rates Too High? (Blame the Fed, Wall Street and Your Neighbor.)

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Mila Adams moved to Utah with her husband and toddler son in May.

The couple’s search for a home of their own has become a race to stay ahead of the rapid rise in mortgage rates. The size of the houses they can afford has shrunk.

“We saw some new buildings and some older homes, but it seems like our purchasing power is going down with each rate hike, and we have to readjust our budgets.” Families planning to grow A house large enough for “High home prices aren’t falling as quickly as interest rates are rising to adjust for that loss of purchasing power. Prices are kind of stubborn.”

The couple’s mortgage pre-approval was revoked when interest rates exceeded 7%. This was due to higher debt levels combined with my husband’s student loans from dental school making the debt levels too high.

“We are very conservative with our finances and just want to have some extra room so that we don’t end up in poverty,” Adams said. “At the moment, I’m a little bit decision fatigued.”

It’s surprising that rapid interest rate hikes by the Federal Reserve aimed at curbing inflation and cooling an overheated housing market have pushed up mortgage rates, making it harder for many to buy a home. not. Changes in consumer behavior and investor decision-making on Wall Street are also responsible for rising interest rates.

According to analysts, the average interest rate on a 30-year fixed mortgage is Recently crossed the 7% thresholdcould be as low as a percentage point if investors, homeowners, and prospective buyers hadn’t sharply changed their behavior in response to the Fed’s move.

“Mortgage rates are up one percentage point because of what’s going on in the mortgage market,” said Breen Capital mortgage analyst Scott Bukta. .”

Lenders take into account three different interest rates when determining the interest rates on mortgages offered to homebuyers.

The base rate is usually tied to the yield (or rate of return) on 10-year government bonds. This is used by most people to move to another house, prepay, or refinance within her 10 years of getting a mortgage. The second rate is associated with the yield differential between those bonds and mortgage-backed securities (MBS). In Wall Street parlance, this difference is known as the “spread.”

Finally, additional interest is charged that reflects the profits earned by lenders, servicers, and other players in the mortgage chain.

This is what happens behind the scenes.

Many banks and other lenders don’t hold onto the mortgages they set up. Instead, they package it into bonds that they sell to investors. Payments made by homeowners, such as interest payments and advance payments, flow to those investors. And the proceeds from selling bonds, which are an important source of funding for mortgage lenders, allow lenders to take out more mortgages.

In normal times, spreads between government bonds and mortgage-backed securities are fairly stable. But it changes quickly when interest rates rise, especially as it does now.

MBS investors, such as insurers, expect interest rates to continue to rise, causing people to stay home longer, slowing down mortgage advances and refinancings. This changes the calculation of the return an investor expects on a holding over a given time frame. Some investors sell bonds rather than stick around in search of higher returns elsewhere. Some demand higher interest rates from lenders to compensate for the additional risk of holding mortgage bonds.

Therefore, spreads, or the amount that fixed income investors are now expected to pay relative to government bonds, widen. So far this year, the spread has more than doubled, from 0.7% to 1.7%. The wider the spread, the more consumers pay because lenders pass the cost of their increased interest rates on to them.

The withdrawal of two of the largest holders of mortgage-backed securities from the market has not helped lenders.

Banks, both lenders and holders of mortgage bonds, are selling these holdings. U.S. commercial banks have sold about $200 billion in government-backed mortgage-backed securities since the central bank first raised rates in March, according to Federal Reserve data. This is a sharp reversal after he bought about $100 billion from last September through March.

The Fed, another large mortgage buyer, is also absent. When the pandemic hit in March 2020, central banks rushed to prop up financial markets, buying government bonds and mortgage-backed securities to lower interest rates and support prices to revive the financial system. But since June, the Fed has allowed mortgage bonds to roll off their balance sheets as they mature.

“Market support is receding,” said Jason Curran, head of structured products at asset manager Columbia Threadneedle. It’s a U.S. bank, too. They haven’t been mortgage buyers all year.”

With demand for MBS so low, lenders who package and sell bonds are offering higher interest rates to lure investors back. These higher fees are also passed on to consumers.

Volatility in the mortgage market is hitting real estate investment trusts (REITs). A REIT is a publicly traded company that originates mortgages and purchases the bonds that serve as collateral. Although REITs are relatively small, they represent a significant portion of the market. Because his MBS purchase of a REIT will help Americans finance housing.

Annalee Capital Management, the largest mortgage REIT, recently announced that its book value (value of assets minus liabilities) has fallen by about 15% as a result of sales in the mortgage market. For AGNC, another large mortgage REIT, that figure was 20%.

REITs borrow money to buy mortgage bonds, originate mortgages, and collect interest on what consumers pay for their mortgages. This makes them very sensitive to changes in interest rates.

To protect against interest rate fluctuations, REITs buy and sell US Treasuries and other securities designed to minimize interest rate risk. For example, when interest rates fall, consumers may buy longer-dated Treasuries to make up for some of the interest payments they lose by paying off their mortgages early.

Mortgage REITs have sold some of these hedges this year as interest rates have risen, adding to the broader sale of Treasuries that also impacts consumer mortgage rates.

“It wasn’t a market for the faint of heart,” said David Finkelstein, CEO of Analee. “The movements we deal with on a daily basis are almost double what the market is accustomed to.”

These interrelated but elusive developments in the mortgage market have real-world implications. For Adams and her husband, who are looking to buy a home in Utah, rising interest rates have slashed the couple’s housing budget by as much as 30% since June.

“It’s an endless feedback loop,” says Adams. “Things are moving very fast. It’s hard to make decisions.”

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