Why some rate quotes are so different and why the “points” are on the rise
It’s been yet another tough week for the mortgage market with rates hitting their highest levels since 2009, but how far have they really risen?
There’s a good answer and then there’s the answer that can be gleaned from the extensive media coverage of Freddie Mac’s weekly mortgage rate survey. As is often the case in times of heightened volatility, survey-based rates tend to lag reality.
On a positive note, Freddie correctly identified a sharp rise in rates as well as their “highest since 2009” status. Unfortunately, the survey continues to lag behind the average lender based on an objective review of actual rate sheets. While Freddie rose to 5.27%, most lenders are at least a quarter point higher.
That doesn’t mean Freddie is “wrong” when it comes to rates. The survey is just limited in terms of what it can tell us about same-day fare availability in a rapidly changing environment. Over longer time horizons and with the aim of having a general idea of the evolution of rates, the survey fulfills its objective.
The other potential complication is that Freddie’s investigation has another cost element that isn’t factored into the headlines. In addition to the fare itself, “points” are also included. 1 point = 1% of the loan balance, paid in advance in order to obtain a lower interest rate. The rate-reducing power of a point can vary over time, but for now, 1 point is generally worth at least 0.25% rate. For example, a rate of 5.25% with 1 point is about the same as a rate of 5.5% without a point.
While it’s great that Freddie is also posting points, the sad reality is that media headlines and consumers tend to focus on the rate itself.
Are people really paying extra points on mortgages right now? Aren’t the points “bad?”
There is an old, popular, and often valid idea that you shouldn’t pay extra points for a mortgage. This is especially true when rates are trending lower overall or if there is another reason a homeowner expects to sell or refinance in the foreseeable short-term future. You will need to hold onto this mortgage for a period of time before the savings on monthly payments will offset the additional upfront cost. There’s also the question of what else could be done with the money today that could benefit your personal balance sheet more than a modest reduction in monthly payments (i.e. paying back other debts, increase investments, etc.).
The thing is, points are almost always simply a choice between paying up front or paying over time. More often than not, it was easier to justify not having paid points for the better part of 40 years. In many cases this is still true, but at the moment points cannot be avoided in certain scenarios!
Why do some scenarios require “points” right now?
Whether or not a loan quote displays “points,” there is always an interest rate and upfront cost associated with any loan. For example, if your lender sells your loan, the loan rate will determine the price the lender will receive. Higher rates mean higher monthly payments, so banks that buy loans are willing to pay more for them up front. Incidentally, this is why, as a consumer, you can pay less upfront when you opt for the higher rate, because the bank that ultimately purchases your loan (“the investor”) will cover the cost you would otherwise have paid in the form of points upline. Your lender gets it anyway.
Here’s the problem right now: Due to market volatility and the rate at which rates have risen, investors are simply not paying for higher rates. It always takes some time for the higher rate market to become active after rapid spikes and 2022 was the fastest spike in decades. Additionally, whenever rates are significantly higher than they have been, lenders fear that today’s new mortgages will be refinanced very quickly as soon as rates drop.
Why wouldn’t a lender want you to refi too soon?
Remember the point (no pun intended) about every interest rate having an associated cost? At higher rates, this cost structure means that an investor can assume $104,000 to purchase a loan with a principal balance of $100,000. They would then have to hold onto that loan long enough to earn at least $4,000 in interest just to break even, because they won’t receive the principal balance of $100,000 until the loan is paid off or repaid.
Where this becomes particularly problematic is for certain loans which inherently entail significant additional costs. Things like second homes, investment properties, lower FICO scores, and higher loan-to-value ratios can quickly rack up several additional cost points that must be absorbed either by paying points up front or through rates. higher interest. Normally, these higher rates would allow the investor to cover these additional costs. Right now, investors aren’t offering much of a premium for higher rates. This leaves borrowers with only one option to pay these points upfront.
Why is all this happening?
Quite simply, the market continues to adjust to a new reality where the Federal Reserve (aka “the Fed”) is rapidly removing the punch bowl of rate-friendly monetary policy that has been in place since the start of the pandemic. This is a subject we have covered quite extensively in recent newsletters, so there is no need to dwell on this point. Here are the links to the last two examples:
The Fed Playbook is already out for next week
Mortgage rates are a bit higher (and much lower) than you’ve been told high (and much lower) You were told
This week essentially brought the same, with the Fed confirming all market fears about the pace of rate hikes and the end of the Fed’s bond-buying efforts. NOTE: Wednesday’s Fed rate hike has NOTHING to do with this week’s move in mortgage rates. This rate hike was priced into the market months ago. Markets were more interested in the official announcement of the normalization of the Fed’s balance sheet. This was also widely expected, but details haven’t been fully confirmed. Conclusion: This week’s rate volatility was the byproduct of traders adjusting to the details of the normalization plan.