A new housing development has been constructed near the Mokelumne River in Stockton, California. Lawrence Yun, the chief economist for the National Association of Realtors, highlights the impact of the Federal Reserve’s actions on the housing industry. While the Federal Reserve’s interest rate hikes aim to control inflation, the bond market, specifically the spreads between treasuries and mortgage rates, presents a bigger concern for the housing industry. The mortgage spread, currently over 3 percentage points, is keeping mortgage rates high and hindering potential homebuyers.
Yun explains that buyers no longer expect the return of 3.5% mortgages and suggests that a 5.5% rate would encourage them to enter the market. The expectation is that mortgage spreads should decrease, bringing relief to homebuyers who have experienced declining affordability since 2020. Historically, spreads widen during times of economic recession. However, as the Fed increased interest rates, mortgage rates rose faster than bond yields. The widening spreads were partly due to the anticipated rise in the 10-year treasury yield and concerns of a recession in 2023.
Recent economic news and inflation reports suggest a reversal of these trends. Inflation has decreased, and the Atlanta Federal Reserve Bank’s estimate of economic growth contradicts predictions of an impending recession. The 10-year treasury yield has reduced, resulting in lower mortgage rates. However, the mortgage spread remains largely unchanged.
A return to normal spreads would significantly impact monthly payments for homebuyers. For example, a $500,000 mortgage at a 7% interest rate would require a monthly payment of $3,327. If rates reduced to 5.8%, the monthly payment would decrease to $2,934. A smaller spread of 1.5 percentage points would result in a monthly payment of $2,777, which aligns with the long-term average. Closing spreads could save borrowers $6,600 annually.
Logan Mohtashami, lead analyst for HousingWire, highlights that the narrowing of spreads last year stabilized the real estate market. However, experts are uncertain if spreads will narrow and mortgage rates will decline at the desired pace. The Federal Reserve’s decision to raise interest rates, the cessation of mortgage security purchases, and the pressure on lenders to demand wider spreads create skepticism.
Furthermore, banks may seek larger spreads on loans as borrowers may refinance next year when rates fall. The Fed’s stance on mortgage rates seems to oppose a decrease, aiming to control inflation. However, market movements often defy the predictions of the central bank. The sustained decrease in inflation and increased consumer confidence may influence market interest rates, regardless of the Federal Reserve’s actions.
Doug Duncan, chief economist at Fannie Mae, suggests that the second rate increase expected by investors may be postponed if inflation remains low. Banks’ responses to changing spreads are difficult to predict, as they must consider potential prepayments and the value of existing mortgages. However, if mortgage-bond values increase, banks may relax spreads, resulting in quicker decreases in mortgage rates.
Overall, the housing industry is closely monitoring the bond market and mortgage spreads, as they have a significant impact on affordability and buyer behavior. The expectation is that spreads will eventually decrease, benefiting homebuyers and stimulating the real estate market.
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