Oct 7, 2023 - Economy

Why mortgage rates are so high

Data: Brookings; Chart: Axios Visuals
Data: Brookings; Chart: Axios Visuals

The main reason mortgage rates are so high — closing in on 8% — is just that long-term interest rates are high. But the main reason mortgage rates are so much higher than other long-term rates is that U.S. mortgages can be prepaid without penalty.

Why it matters: Prepayability is broadly great for homeowners, since it gives them the ability to refinance whenever rates come down. By the same token, however, it's bad for lenders, who are now charging a lot of money to cover their prepayment risk.

State of play: Rate increases in the corporate bond market have been much smaller than those in the mortgage market. The average 30-year mortgage rate has risen 4.6 percentage points since December 2021 — but for a big company like Apple, the yield on its 10-year bonds increased by only 3.2 points over the same time period, per MarketAxess' Bondticker.

How it works: Most lenders make windfall profits when rates go down. The value of the loans on their books goes up, and they can be sold for much greater than face value.

  • Mortgages, however, don't work that way. The minute rates come down by a point or two, homeowners tend to refinance — paying back the loan only at its face value.
  • The higher interest rates rise, the greater they can fall — and the greater the risk that lenders will see a sudden halt to the interest payments they had been promised for many years to come.

By the numbers: Wendy Edelberg and Noadia Steinmetz-Silber of Brookings have an excellent explainer of the different components that make up the roughly 3 percentage point gap between 10-year Treasury rates and 30-year mortgage rates.

  • The so-called primary-secondary spread — basically the amount that mortgage originators keep for themselves to cover their costs and profits — is well within normal levels at about 1.1 percentage points.
  • There's also duration risk, which is related to the fact that a typical mortgage lasts for 7 years rather than 10 years. If 7-year rates are higher than 10-year rates, that will increase the spread between mortgage rates and the 10-year Treasury. Right now, however, that gap is tiny, just one hundredth of a point.
  • The big increase has come in prepayment risk, which currently stands at 1.1 points, double its level at the beginning of the year.

Between the lines: As Axios' Kate Marino explained last year, mortgage rates are also being elevated by the fact that some of the biggest buyers of mortgage bonds have dropped out of the market.

The bottom line: You could always take out an adjustable-rate mortgage instead.

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