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Prepare for the rise in mortgage rates

Economists weigh in on how a modest rise in rates will play out in 2021

U.S. Treasury

As the calendar flipped to 2021, it didn’t take long for the rise in mortgage rates. Just two weeks into the new year, Freddie Mac reported that mortgage rates climbed 14 basis points to 2.79%, a dramatic contrast to 2020, a year in which mortgage rates set record lows 16 times.

Economists across the housing industry believe the era of extreme low rates could be coming to a close, but the transition might be a slow burn.

Freddie Mac’s quarterly forecast estimates that the average 30-year fixed-rate mortgage will be 2.9% in 2021 and 3.2% in 2022. However, the factors that will drive mortgage rate movements are still up for debate.

HousingWire spoke to several economists in the housing industry to get their take on how high mortgage rates will climb in 2021, how lenders will respond, and what impact this will have on the housing market.

What the Fed giveth, can also taketh away.

As the coronavirus pandemic began to ravage the economy, Federal Reserve Chairman Jerome Powell announced in March the central bank would make “unlimited” mortgage backed securities purchases, pushing the average 30-year fixed mortgage rate down to 3.5% by the end of the month. It was the best option to prevent a credit crunch and jolt the economy by making borrowing cheaper, Powell reasoned.

Now, at an average of $120 billion a month — split between $80 billion in Treasuries and $40 billion in MBS — Fed holdings have surpassed $7 trillion, and Fed Vice Chairman Richard Clarida doesn’t see a pullback anytime this year.

To Mike Fratantoni, chief economist at the Mortgage Bankers Association, the current fiscal situation harkens back to the days of 2013’s “Taper Tantrum.”

Back then, former Fed Chairman, Ben Bernanke, announced that the Fed would be reducing the pace of its purchases of Treasury bonds to reduce the amount of money it was feeding into the economy. Bond yields immediately jumped, giving birth to the phrase, “Taper Tantrum.”

Despite the Fed’s vow to keep interest rates low until 2022, Fratantoni said recent Fed speeches revealed they are less committed to asset purchases, and wouldn’t be surprised if said purchases were reduced by the end of year.

“Chairman Bernanke at the time just began hinting that they might slow down asset purchases at some point, and longer term rates jumped a point and a half in a couple of weeks. So, it was certainly a tantrum,” Fratantoni said. “I think we’re set up for the possibility of something like that again. They’re just having a challenge to communicate how they would be able to smoothly exit from that program. The worry is not that they immediately stop purchases but that they begin talking about it more seriously.”

The Treasury is now expected to auction close to $3 trillion worth of bonds this year, and with that amount of supply hitting the market, a historically inverse relationship will see bond prices dropping and yields on the rise.

“While for some time people thought that mortgage rates might be less impacted than Treasury rates, the spread between mortgage rates and Treasury rates has narrowed substantially. Going forward, any increases in Treasury rates are really going to be matched by increases in mortgage rates,” Fratantoni said.

But this incredible buying spree was only ever pushed as a temporary fix to a pandemic-driven problem. The Fed will eventually back off, especially when they hit their fiscal goals, economists said.

“Any rational mortgage banker should realize that when the Fed starts backing away, which they will, especially as we get the vaccine distributed and the economy starts growing, that’s going to remove the biggest buyer of mortgage backed securities and that’ll be upward pressure on interest rates,” said David Stevens, former president and CEO of the Mortgage Bankers Association. “That’s significant.”

Are companies set to ride a smaller refi wave?

In September, data and analytics firm Black Knight estimated there were over 19 million high-quality refinance candidates in America, representing 43% of all 30-year mortgage holders. Even with an estimated $4 trillion in origination volume in 2020 – about two-thirds of which was refi’s – there’s a lot still left in the cup.

Though borrowers flooded the market to take advantage of unprecedented mortgage rates in 2020, the circumstances look less rosy in 2021. For starters, the 50 basis point adverse market fee from the the Federal Housing Finance Agency finally landed in December, and lenders have to weigh whether to eat the loss or increase the price.

That will present some interesting challenges for many of the leading independent mortgage banks, which have been feasting on refis since the pandemic began. About a dozen of them have gone public or plan to do so in 2021 on the strength of historic refi volumes.

“It’ll be interesting to see how they’re able to meet their shareholders objectives,” Stevens said. “Because shareholders aren’t used to the volatility in the mortgage business. I mean banks, banks can offset the volatility because they have other investments that they do. But mortgage companies are monoline and some of the ones that went public are very high refinance,” Stevens said.

The two leaders, Rocket Companies and United Wholesale Mortgage, have both generated far more refi business than purchase since the pandemic started. Their smaller rivals show similar trends.

Homepoint, the third largest wholesale firm, revealed in its S-1 on Jan. 8, that 68% of their origination volume in the first nine months of 2020 was in refinance activity. Compared to 51% in 2019, low mortgage rates had borrowers scrambling to lower mortgage payments throughout the better part of the year. Multichannel lender loanDepot, who filed plans to go public on Jan. 11, also reported 61% refi activity within the same time period.

Investors want to see mortgage companies that can generate profits in all kinds of different environments, and few have proven over the long term that they’re capable of doing that. Several of the companies looking to go public actually lost money in a few quarters in 2019.

On Jan. 13, the refinance index increased 20% from the previous week and was 93% higher than the same week one year ago. Both conventional and government refinance applications increased, with applications for government loans having their strongest week since June 2012.

Unfortunately, news of this refi flurry arrived just one day before the rising mortgage rates report hit economists’ inboxes.

Rising mortgage rates come with benefits.

While extraordinarily low mortgage rates brought new borrowers to the market, inventory in the housing market has struggled to keep up with demand for months.

Data from the National Association of Realtors and U.S. Census Bureau revealed that the national supply of homes for sale in September fell to the lowest level ever recorded. After months of severe shortages, upward pressure on home price appreciation had consumers battling it out for the limited supply.

But Andy Walden, director of market research at Black Knight, said this rise in mortgage rates may be just what a hot housing market needs to catch up.

“So typically, a 1% movement in rate equates to roughly a 10 to 12% movement in buying power,” Walden said. “So this recent increase in mortgage rates, decreased buying power by in the range of one to one and a half percent. So it did pull that buying power a little bit, a very slight headwind to the purchase market which may be welcome given how hot that purchase market has become”

If bidding wars do decline as a result of heightened housing stock, first-time homebuyers who had been pushed to the wayside from upwards pressure on home-prices may finally get some skin in the game.

Don Layton, former CEO of Freddie Mac, noted higher home prices mean higher down payments, so would-be homeowners need more cash to enable a first-time home purchase.

“In other words, housing has become so much a ‘tradeable asset,’ with prices moving up and down to reflect supply and demand, that expansive monetary policy is turning into asset inflation, which hurts first-time homebuyers, and thus reduces at least somewhat the hoped-for impact of rate reductions to help the economy,” Layton said.

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