Are 30-Year Mortgages On The Way Out?

Higher mortgage rates may be forcing investors away from 30-year fixed-rate loans. The problem is that while rates are higher than a year ago they are still not high enough for many investors.

Both the National Association of Realtors and the Mortgage Bankers Association are predicting mortgage rates in the mid-5 percent area by year end. These rates are higher than a year ago but arguably not “high” enough given long-term historic rates. As a result some fixed-rate investors are now leaving the market.

Here’s why: If you have a $1,000 bond that pays 3 percent you earn $30 per year. If  interest rates move to 4 percent the market value of the 3 percent bond declines to $750 because now $750 at 4 percent will generate $30 per year. The investor with the $1,000 bond at 3 percent can either sell at a loss or hold until maturity. However, by holding the investor loses the opportunity to  re-invest at a higher rate.

This is a real-life scenario given that 30-year fixed mortgage rates in mid-January were up better than a full percentage point when compared with a year ago. If you’re a mortgage investor the past year has been miserable as interest levels have moved from near-record lows to “higher” rates which are not high at all compared with the rates seen during the past four decades.

Mortgage Investors
One general measure of investor preferences is PIMCO’s well regarded Total Return Fund Institutional Class. During the past five years annualized returns for this fixed-rate fund equaled 6.94 percent — but for the past year the return has been -1.03 percent.

Bloomberg News reports that in 2013 clients removed $41 billion from the Total Return Fund, a fund which holds $237 billion. What’s become of the $41 billion is unclear: some of it may have been invested in stocks while a lot is likely being held on the  sidelines, simply waiting for better rates of return.

Those with a need for mortgages want lots of fixed-rate investors in the marketplace because mortgage rates and the returns on fixed-rate securities generally move in tandem. As Investopia explains, “the interest rate on 30-year fixed-rate mortgages offered to  consumers should move up or down with the yield of the U.S. Treasury 10-year  bond.”

But why would a 30-year mortgage be compared with a 10-year Treasury bond? Would not the better measure compare 30-year mortgages and 30-year securities? It seems logical, however, most 30-year mortgages are not outstanding for three decades,  instead they’re typically paid off much sooner as properties are sold or refinanced and that’s why investors compare mortgage rates with 10-year Treasury bonds.

Will 30-Year Mortgages Survive?
For investors the real question at this time is whether 30-year fixed-rate loans are at all attractive.

If you’re an investor you may not want to fund fixed-rate 30-year loans at today’s interest levels because such rates are certain to rise. ARMs are more flexible and a way to capture higher rates in the future.

Most lenders are making “qualified mortgages” today, the plain-vanilla loans FHA, VA and conventional financing favored under Wall Street Reform. However, it’s perfectly possible to make non-QM loans such as subprime loans and as market risks become better understood it’s likely that such forms of financing will become more common. For instance, figures from the Urban Institute show that 36.2 percent of the private-label securities market is now represented by subprime financing, loans worth $285 billion.

The new jumbo and subprime loans will be different than the products offered during the last decade. As the Consumer Financial Protection Bureau explains, “under the new Ability-to-Repay Rule, mortgage lenders must look at customers’ income, assets, savings, and debt, and  weigh those against the monthly payments over the long term — not just a teaser or introductory rate period. As long as they check the numbers and the numbers  check out, lenders can offer any mortgage they reasonably believe a consumer can afford.”

This statement from the CFPB can be read as both an invitation and a warning: It welcomes forms of financing outside the qualified mortgage standard but insists  that lenders must carefully document the loans they originate — that “check the numbers” requirement.

Meanwhile, looking at the financial carnage from the past year there’s no doubt that some mortgage investors are saying, “not now” and maybe “not ever” to 30-year fixed-rate loans. The ironic part of the story is that as interest rates rise more investors will be drawn back into the bond and mortgage markets — and of course more investor activity will hold down rates, the central problem long-term investors are trying to avoid.

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