Courtesy Steven Luttman
By Steven Luttman
U.S. homeowners are sitting on approximately $35 trillion dollars of home equity. While rising values have been great for some, simultaneous higher prices and mortgage rates continue to leave many out in the proverbial cold. Should relief come, many expect it would not be in the form of falling prices, but instead in lower borrowing costs. We’ve seen the Federal Reserve lower rates on the short end of the curve with little/no impact to housing, so where else can we look? Spreads.
When we say ”spread”, we’re not referring to your favorite sports team catching six points determined by Las Vegas against a rival. Instead, it’s the difference between two benchmark rates. From a mortgage loan perspective, the significance of the 10-year U.S. Treasury yield can’t be overstated. On the surface this may not make a lot of sense. According to online lender Homebuyer.com roughly 9 out of 10 applications in 2022 were for a fixed rate mortgage spanning 30 years. With that in mind, why not focus on a 30-year instrument for a true apples to apples comparison? When taking into account refinances along with property sales, the average mortgage lifespan is actually only 8 years long. Turns out your “forever home” is rarely ever that. Keep this in mind when deciding if buying down your mortgage rate is in your best interest.
Mortgage rates trade above their Treasury counterpart due to several factors. These include servicing costs, secondary market appetite and duration risk. Equally important however, is default. While unfortunate, the chances of a household not making payments (1.73% of mortgages were delinquent as of Q3 2024 according to the Federal Reserve System) does exist. Compare this with U.S. government debt, which is viewed globally as “risk free”. The belief in repayment is in large part why there is a discrepancy.
While a strong correlation in movements between the two does exist, differences do occasionally occur. Economic conditions play a role in the discrepancy. As explained by Grey Gordon, Senior Economist with the Federal Reserve Bank of Richmond in his 2023 research paper “Mortgage Spreads and the Yield Curve”, spreads increase during times of financial uncertainty. The thesis is money flows into long dated government bonds for security, inverting the yield curve. Refinance activity from owners chasing a lower rate shortens expected term duration, causing mortgage prices to become more sensitive to short-term Treasury rates. Ultimately this leads to higher mortgage rates relative to the 10-year Treasury yield and creates wider mortgage spreads. A very complicated way of saying that evidence shows forces push up mortgage rates during times of economic slowdown.
