Why Lenders Want A New Mortgage Deal

Nobody likes mortgage rates. No matter what the cost of real estate financing is today there’s always a preference for less. Much less.

This raises two points. First, mortgage rates today are ridiculously low by historic standards. Second, they should be lower.

Let’s start with the first idea. Mortgage rates as this is written stand at roughly 4.1 percent for 30-year FHA loans, 4.4 percent for conventional financing and 4.3 percent for jumbo loans. Your parents and grandparents would have walked barefoot across a glacier to get such financing: According to Standard & Poors the average mortgage rate during the past 40 years was 8.6  percent so today’s mortgage rates are half off when compared with historic interest levels, a huge discount.

That said, mortgage rates should be lower.

Mortgage rates reflect supply and demand for a basic commodity, money. When supply is greater than demand rates should be pressured down. When demand is steep but supply is constrained we would expect rates to rise.

Look at supply. Banks have more than $2 trillion in “excess” cash, according to  Maury Harris, managing director and chief U.S. economist at UBS. If that’s true —  or even half true — there are huge piles of cash which lenders would dearly love to lend. Why? Because cash in a vault earns no money. In fact, because of inflation cash in a vault, or in a mattress, loses buying power. Lenders have every incentive to make loans in such a situation, one reason credit requirements have eased during the past 18 months.

The inflation rate for April was 2.0 percent. That’s not high at all, however it translates into big money when you have $2 trillion sitting in a heap and not earning interest, say $40  billion a year in lost buying power.

Do lenders want to lose $40 billion a year? Not hardly. Can they do something about it? You bet — they can reduce interest rates and thus make more loans and clean out stuffed vaults.

Mortgage Rates and Time
Lower rates sound good in theory — at least for borrowers — but there’s a problem:  Folks with capital have no objection to lending money at today’s low rates for a short period. However, they’re terrified by the idea of a 30-year commitment.

As much as lenders hate to lose buying power today they’re even more petrified by the  thought that they could have bigger loses in the future. Imagine that an investor loans money today at 4.3 percent for a $100,000 mortgage. The lender is now making more than the rate of inflation so its money is creating real wealth.

Now imagine that five years from today rates crawl back to 8.6 percent. The lender is still earning 4.3 percent. It would dearly love to earn 8.6 percent but its capital is tied up in that rusty old loan. What to do? One option would be to sell the old paper and use cash from the sale to create a new loan at a higher rate. That sounds good except that no one will buy a $100,000 note at 4.3  percent in a world where 8.6 percent returns are available. What note investors will do instead is buy a loan with a $100,000 balance at a price which produces an 8.6 percent rate of interest, say $50,000 or so.

Here’s why: $100,000 x 4.3 percent = interest worth $4,300 per year. The note buyer divides $4,300 by 8.6 and multiples by 100. The result is a current note value of $50,000.

What’s curious about today’s mortgage rates is that some forecasters suggested rates would reach 5 percent of so during 2014. They may be right — the year is not even half over. That said, rates have largely stalled and with $2 trillion in their vaults lenders are wondering how they can maximize returns.

Mortgage Rates and Options
The  answers are fairly clear: Sell more ARMs where rates can move up and down and  the risk of inflation is shifted to the borrower, or sell mortgages with shorter terms, say 15, 20 or 25 years, rather than 30 years.

The next time you speak with a lender ask about financing with fewer years or a variable rate. You might find interest levels more to your liking if you do — and your lender might gleefully make some progress cleaning out the vault.

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