According to an analysis done by Brean Capital, borrowing rates have increased in the last three years, leading to less than 5% of the homeowners in the U.S. saving on refinancing on their mortgage loans.
Impact of rising mortgage interest rates
The figures may be even lower. If one takes out the borrowers who cannot refinance or are bothered, such as homeowners with a low loan balance, then only about 0.15% of the loans will be refinanced. This is based on a study by FHN Financial on mortgage bonds of 30 years.
According to the Mortgage Bankers Association data, home loans refinance applications have plunged by 60% since last August. The drop in such refinancing can be painful for holders of mortgage bonds whose investments get tied up for a more extended period and prevents them from reinvesting in bonds at higher yields.
Some investors are buying the securities, hoping that it will not worsen. Mortgage bonds have already lost 4.6% this year as the overall broad bond market has weakened. However, according to Bloomberg’s data on Wednesday, they are performing better than corporate bonds and treasuries.
The gap in yield between the 5 and 10-year treasuries and the current coupon mortgage is the highest since 2020, as per Walt Schmidt, FHN mortgage strategist. The prices are already reflecting on expectations of a further hike in rates by the Federal Reserve to around 2.25% after the tightening commenced last week.
More than $9 trillion worth of mortgage bond market is going through excess pressure from shrinking demand from Fed, as they have stopped purchasing the securities. Investors are getting ready for the central bank to reduce the mortgage holdings, which are not expected to reinvest principal this gets back by buying more MBS. Eventually, the Federal Reserve will sell all its remaining MBS and focus only on Treasuries.
As new mortgage applications are low, along with the refinancing in general, there is another active segment in the market, such as “cash-out transactions.” Borrowers get a new loan at a higher balance and, with the surplus funds, use it to renovate old homes or make additions.
According to Scott Buchta, fixed Income strategy head at Brean Capital, people have an economic incentive to take out equity from their homes. He expects this activity to continue.
Some investors scout for mortgage-backed bonds whose borrowers are expected to carry out more refinancing, such as big loans and large equities supporting them. These borrowers are wealthier and can manage to borrow more. The bonds that are linked to such borrowings could have shorter tenors and end up giving good returns.
The average mortgage rate on 30-year is 4.42%, after reaching a low of 2.65% in January 2021.
