When to Lock

[carlover]

Over the past few weeks I have been trying to make sense out of what drives mortgage interest rates. For conforming loans the ten year treasury yield is a pretty good bet. In general if treasury yields go down today, mortgage rates will go down tomorrow, here is the treasury’s web site which posts daily treasury yields at around 5PM EST:

http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

Something interesting has happened recently in the CONFORMING loan market where loan rates are not matching drops in treasury rates

[img_assist|nid=4696|title=Conforming Rates vs. 10 Year Treasury Yield|desc=|link=node|align=left|width=466|height=424].

In the past the average 30 year conforming loan interest rate averaged around a 1.1% premium over the treasury yield. Currently, according to bankrate.com data this premium has gone up to around 1.5% to 1.6%. This seems to counter all of the arguments I have been hearing that the conforming mortage market has been unaffected by the subprime scandal. This also means that jumbo loan rates are even more inflated than is generally being acknowledged, commanding a premium of around 1.5% over historical norms.

What really determines conforming loan rates. Since Fannie Mae and Freddie Mac purchase loans the real determination of rates seems to be the interest rate they require to buy loans. They call this the required net yield or RNY. These can be found here:

http://ww3.freddiemac.com/ds1/sell/sffrny.nsf/frmDisplayRNY?OpenForm

These are published every hour of the business day and closed down almost a quarter of a point on friday, so expect conforming rates to be down a similar amount on monday. In general the rate posted at the end of the day will determine mortgage rates the following day as most lenders post rates which are good for the day.

So far as I can tell this basically gives you a crystal ball to look a day into the future of mortage rates. If you are thinking about locking in a rate you can at least tell if you should do it today or wait until tomorrow. Beyond that it’s anyones guess. Please let me know if anyone has seen conflicting evidence to what I’m posting.

[Bubblesitter]

The correlation between between 30yr fixed mortgage interest rates and 10 yr treasury yield seemed to break down in early Aug, just when the liquidity/credit crunch started to hit the fan.

All sorts of interesting things went screwy around that time. A number of the “quant” hedge funds were caught off gaurd when the market did not behave as predicted.

These recent liquidity and credit crunch events will keep PhD economists busy for years. I can see alot of dissertations coming out of this one. This will make the LTCM fiasco in the late 90s look like child’s play.

[SD Realtor]

I have always been a strong advocate of the 10 yr as a barometer for long term mortgage rates. However Bubblesitter really nailed it that the correlation seemed to fall apart as the credit crunch has grown. As the original poster indicated the less risky the loan the stronger the correlation (plus some sort of margin)… However as you move away from conforming loans all bets are off.

Second point is that I disagree with the statement that mortgage rates follow the 10 year up and down some what instantaneously. Rates will always move up immediately when the 10 year moves up. They definitely do not move down immediately. Usually they do not move down unless the 10 year has moved down and stayed down for a few days. Like we always say…. sticky on the way down.

SD Realtor

[Bubblesitter]

LTCM – Long Term Capital Management. These guys were always the smartest guys in the room. Myron Scholes (of Black&Scholes fame) and Robert Merton who shared the 1997 Nobel Memorial Prize in Economics founded this Hedge fund.

It failed spectacularly in 1997. Up until recently Hedge fund collapses had been rare, now we are seeing increasing numbers fail. http://hf-implode.com/

LTCM analysis has been a staple of MBA programs for a number of years, there is HBS case study on it.

More on LTCM at
http://en.wikipedia.org/wiki/LTCM

Here’s an excerpt,
“The company had developed complex mathematical models to take advantage of fixed income arbitrage deals (termed convergence trades) usually with U.S., Japanese, and European government bonds. The basic idea was that over time the value of long-dated bonds issued a short time apart would tend to become identical. However the rate at which these bonds approached this price would be different, and that more heavily traded bonds such as US Treasury bonds would approach the long term price more quickly than less heavily traded and less liquid bonds.”

Bubblesitter

[Bubblesitter]

While many hedge funds are having problems these days, some are doing spectacularly well.

http://www.marketwatch.com/news/story/paulson-hedge-fund-up-410/story.aspx?guid=%7BFDB43747%2DF8FF%2D4B30%2D8CB8%2DD3C2ED738CDC%7D

Excerpt from Marketwatch,
”
SAN FRANCISCO (MarketWatch) – A hedge fund run by $20 billion firm Paulson & Co. has surged 410% so far this year as subprime bets paid off.
The Paulson Credit Opportunities fund, set up last year to take advantage of potential mortgage turmoil, returned 26.67% in August, leaving it up 410% in 2007, according to a person who has seen the firm’s most recent performance update. ”

[carlover]

There is definately some lag in drops in the conforming rate relative to drops in the 10 year treasury. But the close to 0.2% drop in the Freddie Mac 60 day RNY by late friday afternoon (which dropped along with and actually exceeded drops in treasury yields) will cause rates to drop considerably on monday. I would be surprised if rates dropped by less than a 1/8 of a point on monday for conforming loans. I wouldn’t be surprised to see conforming rates drop to around 5.5% – 5.75% by the end of September barring some miraculous recovery of the stock market prior to that.

[carlover]

As promised rates dropped by about 1/8 of a point today on both conforming and even jumbo loans. Based on what happened today with treasuries and the RNY as discussed in the original post, I would expect rates to drop another 30 to 40 basis points (0.03% to 0.04%) tomorrow.

Conforming Rates:
[img_assist|nid=4727|title=Conforming|desc=|link=node|align=left|width=466|height=424]

Jumbo Rates:
[img_assist|nid=4728|title=Jumbo Rates|desc=|link=node|align=left|width=466|height=424]

The scaling on the jumbo chart makes the treasury swings look much larger than they actually are due to the wild fluctuations in Jumbo loan rates over the last month. However, even jumbo rates are coming down and many credit unions and even Washington Mutual have backed off on the large premiums they were charging on Jumbo mortgages. Several credit unions I use are back down to around a 3/8 of a point premium on Jumbo’s over conforming loans. Also many banks are charging really high rates for Jumbo loans with zero points, but paying points is buying a much larger reduction in rates than it used to. Many jumbo loans are coming down 0.5% per point, vs. a more typical 0.25%. This tells me banks think the jumbo rate premiums will be shortlived and if you are willing to front some money for points they are willing to give you a much lower rate.

[Arty]

I have a quick question. Does it really matter that much of few % points when your home value is dropping faster than the interest rate? Once your home worth less than your loan, you are upside down and can’t get a loan anymore at least not at the level of your old loan. Am I right?

[SD Realtor]

I am not so sure I have ever in my life seen rates move 30-40 basis points down in a single day. I have seen them move up that much but never down.

So I disagree on that point.

However I do absolutely agree with you that the high premiums we saw since the beginning of August may indeed be shortlived. I think many in the industry thought that the reaction was an overreaction and that time was needed to smooth it out. As we have had several weeks of relative calm on that front indeed we are seeing the wheels get a little grease. That will most likely continue until there is major news to disrupt it…I use the term until rather then unless because I feel this will be a recurring theme… credit gets tight on lots of bad news… then no news for awhile so it loosens up… then it tightens up again on bad news… repeat lather rinse…

SD Realtor

[carlover]

Arty, I don’t disagree with you that declining values are not going to be totally alleviated by declines in interest rates (barring returns to the low rates of 2003, 30 year fixed at 5.3%). However as in the past both affect affordability, and therefore lower interest rates will actually affect how much prices decline. Will prices still decline, probably, but lower interest will blunt the impacts of ARM resets as they won’t be as severe on a percentage basis. Housing prices and interest rates do not move entirely independently. The purpose of this post was to provide information to the readers of this site on some easy methods to get a read on the direction of mortgage interest rates.

A lot of people on this site feel that housing prices are going to drop drastically but I don’t buy it. What has really happened over the last 10 years is a drastic devaluing of the dollar, rather than a drastic increase in real estate prices. If you were going to buy a house with gold it would not cost much more today than it would have 10 years ago.

[img_assist|nid=4735|title=Gold|desc=|link=node|align=left|width=466|height=285]

Since major exporters like China have had their currencies pegged to the dollar this hasn’t led to significant inflation over the same time period. Will that continue, not likely.

[carlover]

SD Realtor, you’ve never seen price declines of 0.03% to 0.04% in a single day? Swings of an 1/8 of a point at individual lenders are common, at the least they adjust by a 1/16 at a time, but mostly they adjust by a minimum 1/8 and move points around to make up any difference. If you look at the charts I attached earlier the shape of the declines (rate of decline) are not much different than those shown earlier in the year. The interesting thing the charts show is that mortgage rates seem to lead treasury rates down rather than follow them, except in the lates decline of course! Note that this may be caused by the different timing for treasury data vs. Mortgage (weekly for treasuries, daily for mortgages).

[(former)FormerSanDiegan]

I’m thinking a good time to lock will be in 2009.

[SD Realtor]

Arty I have never seen lenders move long term mortgage rates by 40 basis points in a single day in the down direction. In general the only reason they move down is due to competition. Yet they move them up at the touch of feather. I am not talking about treasury yields, please reread, or rather I will restate it here. I have never seen lenders move rates down 30-40 basis points on a single movement. I have seen them move them down incrementally over time.

Your post said you expected rates to move down 30-40 basis points. To me a rate is the rate quoted given no buydown, it is not the treasury yield, or fed funds rate or libor or anything like that, nor is it the buydown amount. Again, and I am not a mortgage broker, I am talking about a simple long term mortgage rate you will get quoted. Now there very well may be a chunk down simply as the credit market greases up a bit to make up for the overreaction we have seen. However I will be very surprised to see that. I would envision small slivers down as each lender tries to undercut each other as long as the secondary market will purchase these instruments.

SD Realtor

[carlover]

Mistake in my earlier post, I meant 3 or 4 basis points, not 30 or 40. I put it correctly in terms of interest rate at 0.03 to 0.04%, but was off by a zero on basis points.

I totally agree with your assessment and think that your postings are some of the most helpful on this site.

[SD Realtor]

heheheh –

now we are talking! totally agree with ya.

SD Realtor

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