As the outbreak of Covid-19 (Coronavirus) continues to spread around the globe, there is a huge amount of uncertainty in almost every aspect of our lives. How will our jobs be affected? How many will perish due to this novel disease? How will growing restrictions affect the US economy?
Unfortunately, nobody truly knows the answers to these questions – and we likely won’t for months to come. However, there’s an old piece of advice that remains very valuable in today’s uncertain environment: We should all work to improve the things that are within our control. And for homeowners, that means keeping track of changes in refinancing rates to ensure the most savings possible.
Since the global outbreak of COVID-19 began to accelerate in late January, mortgage and refinance rates have been trending downwards – but not without a whole lot of volatility along the way.
At the beginning of 2020, refinance rates on 30-year fixed terms averaged 3.96%. On March 25th, the average 30-year fixed terms for mortgage refinancing had fallen to 3.29% – a drop of 0.67% APR. In layman’s terms, this means that the average refinance rate has dropped nearly 17% in the last 3 months.
However, the tumultuous period of Q1 2020 saw rates spike upwards and downwards dramatically. In mid-March, rates temporarily spiked to 4.1% – higher than they started the year at. Some mortgage issuers have reported rates of 5.5% or more.
Under normal circumstances, mortgage and refinance rates are typically very stable. They are affected by changes in federal interest rates and movements in the bond market (and particularly in the mortgage-backed securities market), but rarely do terms swing this dramatically.
Matthew Graham, COO of Mortgage News Daily, referenced the spike in volatility in a report from Realtor.com:
[mORTGAGE RATES ARE] “THE MOST VOLATILE THEY HAVE EVER BEEN, BY A WIDE MARGIN”
What is Causing the Volatility in Refinance Rates?
The wild swings in refinance rates during March 2020 (and likely beyond) are due to a combination of complex factors. To help you understand, here are the main variables currently affecting mortgage rates:
1. Volatility in the Bond Market
When banks issue mortgages, they typically do not keep them for the life of the loan. Most banks will issue a mortgage, then turn around and immediately sell the loans to investors. Dozens or hundreds of mortgages are bundled together and sold as mortgage-backed securities, otherwise known as mortgage bonds.
Mortgage bonds are viewed in a similar light to U.S. Treasury bonds. They are both seen as a safer, but lower-yielding investment than the stock market or other riskier asset classes. When the stock market becomes more volatile, typically investors flock to bonds as a safety net. However, as governments around the world issue hundreds of billions of dollars in treasuries to fund stimulus plans, the market is absolutely flooded with bonds.
With massive amounts of bonds on the market, bond prices are down. Bond yields move in the opposite direction of bond prices. So when the price of mortgage-backed securities on the secondary market goes down, mortgage rates go up. This volatility is bumping up against the gradual lowering of mortgage rates due to interest rate changes, creating an extremely volatile environment.
2. The Great Cash-Crunch
When uncertainty floods the financial market, there’s one asset class that everyone wants: Cash. Cash presents the ultimate flexibility during times of financial uncertainty. Everyone – from average Americans to the largest hedge funds in the world – are flocking to cash in huge numbers.
And as investors hoard cash, they are much more hesitant to purchase mortgage-backed securities, which would lock up their funds for years. This further deflates bond prices, edging mortgage and refinance APRs ever higher.
But as the financial situation and market sentiment changed on a daily basis, investors saw huge swings in just about every asset class – including mortgage-backed securities – causing a whipsaw action in mortgage APRs and refinancing rates.
3. Changes in Demand for Refinancing & New Mortgages
As mortgage rates began to trend downwards earlier in the year, demand for mortgage refinancing spiked. As thousands of Americans applied for refinancing, mortgage issuers were swamped with applications. As a way to slow the onslaught, some issuers proactively raised their rates.
But as the health crises worsened, the number of new home buyers applying for mortgages dropped off significantly. As state-wide shelter-in-place restrictions were enacted, many buyers decided to wait it out. And just as increased refinancing demand caused a spike in rates, the decreased interest in new mortgages caused a decline in mortgage APRs.
4. Interest Rate Changes
As part of their efforts to prop up the economy, the US Federal Reserve slashed the benchmark interest rate to as low as 0%. This federal funds rate impacts everything from the cost of small business loans to mortgage and refinances rates.
Many Americans expected that a significant drop in the federal benchmark rate would lead to a similar drop in mortgage rates. However, most fixed-rate mortgages are barely effected by changing interest rates. Adjustable-rate mortgages (ARMs) are much more sensitive to interest rates. So, we saw a dip in ARM rates, but little movement in fixed rates due to the federal rate cut.
5. Monetary Stimulus by the Federal Reserve
The Federal Reserve has implemented several policies aimed at propping up the economy, and specifically at stabilizing credit and bond markets. This includes a pledge to purchase $200 billion in mortgage-backed securities (MBS) every month – a limit which has now been lifted to “unlimited” purchasing of bonds and MBS.
This bond-buying by the Federal Reserve provides a backstop to the value of mortgage-backed securities, preventing them from a complete sell-off. By buying mortgage bonds on the secondary market, the Fed’s actions have been helping to keep mortgage rates from spiking even higher (again, mortgage APRs move in the opposite direction of mortgage bond prices).
6. Risk Premium
Banks are in the business of managing risk. As economic uncertainty grows, the risks of issuing mortgages increase. Since the future of the global job market is uncertain, many banks are tightening their lending policies to hedge against risk. This also causes rates to tick upwards, as banks factor in a “risk premium” on new debt issuance.
Where are Mortgage Refinance Rates Going from Here?
We’ve explained how the coronavirus has affected home refinancing rates so far, but what direction are they heading now?
While nobody can predict the future during these uncertain times, it’s likely that refinance rates will stabilize soon, and the volatility will decrease. This will hopefully make it easier for homeowners to secure a favorable rate.
The most likely scenario is that rates continue to trend downwards. The Federal Reserve will continue its bond-buying program, which will increase liquidity and drive rates down.
To be clear, the goal of the Federal Reserve is not specifically to decrease mortgage APRs. Rather, the Fed aims to improve liquidity, preventing credit markets from freezing up, as they did in 2008.
But of course, by buying mortgage-backed securities, the Fed is also helping to keep interest rates down. When banks and investors are hesitant to purchase these bonds – locking their money up for years to come – the Fed is stepping in as a sort of lender of last resort.
In other words, the Fed is making it easier for banks to lend at favorable rates. Banks will be more willing to issue mortgages and refinancing packages at low rates because they know that the Federal Reserve will buy the mortgages if investors are unwilling or unable to do so.
How Low Could Refinance Rates Go?
While nobody knows for certain, many experts anticipate rates on the 30-year fixed mortgage to settle in the range of 3%.
Joel Naroff, president of Naroff Economics, noted that based on bond yields,
[mortgage rates will likely be] “in the 3% range, plus or minus 25 basis points”
A likely estimate is somewhere between 2.75% and 3.25% on the 30-year fixed mortgage. Typically, rates for new mortgages and refinances are similar if not identical.
The relationship between the coronavirus and mortgage rates has caused a lot of confusion – and there’s still a lot of uncertainty moving forward.
We don’t know how long the Fed will continue its bond-buying program. We don’t know how the Coronavirus will affect the overall economy. And we don’t know how financial markets will respond to the growing uncertainty.
What Should Homeowners Do?
If you’re a homeowner weighing a refinance, what should you do?
Use a Refinance Calculator – To understand how much you could potentially save by refinancing, use a refinance calculator. These calculators factor in the difference between APRs, while also considering the significant costs of refinancing.
Consider Refinancing Costs – While refinancing to a rate that’s even slightly lower than your current one may seem wise, it’s important to remember that refinancing comes with significant out-of-pocket expenses. Refinancing costs vary depending on the value of your loan and other factors, but most homeowners can expect to pay $4,000 to $6,000 or more to facilitate a refinance.
Seek Preapproval – You can typically get pre-approved for a mortgage or refinance package without locking yourself into anything. By applying early, you can find out what your actual interest rate will be, and if it’s worthwhile to refinance. There may be some costs involved, so be sure to ask the issuer for details.
Stay Informed – The coronavirus outbreak is a rapidly developing situation which is changing every day. Likewise, the financial industry’s response to the growing economic disruption is evolving daily. To make the most of the uncertainty, it’s best for homeowners to stay informed of changes in the refinance market.