Mortgage_Market_Abnormalities
00:00:00.000 | Hello, everybody.
00:00:01.000 | It's Sam from Financial Samurai.
00:00:02.680 | And in this episode, I want to talk about the mortgage market and specifically mortgage
00:00:07.240 | market abnormalities.
00:00:09.580 | The number one economic indicator or financial indicator I like to track is the 10-year bond
00:00:14.800 | yield.
00:00:15.800 | The 10-year bond yield tells you a lot of things.
00:00:18.200 | You can write books about what the 10-year bond yield is saying.
00:00:22.280 | And after the election results on November 7, we saw that the 10-year bond yield spiked
00:00:27.920 | higher to about 0.97%.
00:00:31.160 | But in actuality, the 10-year bond yield has been rising steadily from a bottom of around
00:00:36.160 | 0.51% in early August to about 0.85% up until the election results.
00:00:44.540 | And concurrently, what's been happening is that the average 30-year mortgage rate has
00:00:48.940 | been going down while that 10-year bond yield had been going up.
00:00:53.600 | At first, I was thinking to myself, this must be a mortgage market anomaly.
00:00:58.240 | You know, there's a kink in the system.
00:00:59.680 | It'll right itself eventually.
00:01:01.760 | But after about three months of this disconnect, it's clear that something's going on with
00:01:06.600 | the 30-year fixed-rate mortgage.
00:01:08.960 | And we need to get to the bottom of it.
00:01:10.820 | The other mortgage market anomaly is that the average 15-year mortgage rate is way below
00:01:16.520 | the average 5.1 arm rate.
00:01:18.840 | We're talking 50 basis points or a half a percentage points lower than the 5.1 average
00:01:24.440 | rate.
00:01:25.680 | And this generally doesn't happen because longer-term duration loans charge higher rates.
00:01:31.880 | It's just like if your buddy were to ask you to borrow $20 and if he pays you back tomorrow,
00:01:37.600 | you won't charge him an interest rate.
00:01:39.240 | But if he says, I want to borrow $100,000, which you're probably not going to lend him
00:01:44.900 | over a 30-year period of time, you're certainly going to demand a higher rate because inflation
00:01:50.620 | is going to eat up the value of the dollar.
00:01:53.640 | So based on the time value of money, longer-term duration loans charge higher rates.
00:01:59.540 | And with the 15-year fixed, generally, a 15-year fixed mortgage is more expensive than a 5.1
00:02:06.760 | arm or a 7.1 arm or a 10.1 arm, right?
00:02:09.240 | Because the arms are shorter duration loans.
00:02:11.920 | So the question the intellectually curious should ask is, why did the average 30-year
00:02:16.160 | fixed rate decline when bond yields went up?
00:02:19.760 | The simple answer is that banks were more able to lend once they got through a tremendous
00:02:24.560 | refinance backlog and hired more people.
00:02:28.080 | When the pandemic hit in March 2020, lending standards tightened tremendously.
00:02:32.760 | A lot of the bankers were thinking, uh-oh, this is back to 2008, 2009 financial crisis.
00:02:39.720 | Our loan book is going to get hit.
00:02:40.880 | There's going to be defaults and so forth.
00:02:43.640 | So the lenders and the underwriters were like, well, OK, we're going to take our time.
00:02:47.640 | We're only going to lend to the highest credit-worthy borrowers.
00:02:51.780 | And refinances took weeks, if not months, longer than normal to close.
00:02:56.160 | About a month after the lockdowns began, I got pre-approved for a mortgage.
00:03:00.600 | But instead of taking one to two weeks, it took four-plus weeks.
00:03:04.840 | And it's just because things were all backlogged.
00:03:07.500 | At the same time, demand to refinance skyrocketed, given rates fell by over 1% in just one or
00:03:14.400 | two months.
00:03:15.460 | So many lenders found themselves short-staffed.
00:03:17.840 | And they began aggressively trying to hire to meet the increase in demand.
00:03:22.040 | And so the finance industry is very cyclical in nature.
00:03:24.800 | It's kind of boom and bust.
00:03:26.480 | And you can never really time it right.
00:03:28.660 | And so managers are trying to smooth out the cycles by having the right amount of staff.
00:03:35.000 | But in this case, it was quite a shock.
00:03:38.240 | Given it takes time to hire people and train people to help dampen the demand volume, lenders
00:03:44.120 | decided to charge a higher spread over an index.
00:03:47.420 | And that index is usually LIBOR.
00:03:49.880 | So instead of charging just 2% above LIBOR, lenders began charging 2.25% or 2.5% above
00:03:56.640 | LIBOR.
00:03:57.640 | This is all about demand management here.
00:04:00.920 | And by charging a higher spread, banks can therefore earn a higher profit margin on the
00:04:06.360 | loans that they do close.
00:04:08.880 | So banks that found themselves more undermanned than others rationally charged higher mortgage
00:04:13.280 | rates.
00:04:14.280 | And as a result, consumers had to diligently shop around to get the best rate.
00:04:17.880 | So what's going on today?
00:04:19.120 | Well, lenders have more capacity to handle refinances and purchase loans because demand
00:04:24.440 | has subsided and more people are employed to handle the workload.
00:04:27.800 | I spoke to my mortgage officer the other day and he said those people who wanted to refinance
00:04:32.400 | have already refinanced.
00:04:33.400 | And he said he was focusing more on purchase loans going into 2021 and beyond.
00:04:39.000 | So as a result, given more capacity, lenders are now charging lower spreads to help boost
00:04:44.880 | business once more.
00:04:46.280 | Again, it was a pull forward of a lot of refinancing earlier in 2020.
00:04:51.560 | And now 2020 second half compared to 2020 first half is looking pretty light.
00:04:57.040 | It's probably going to be, I would think, down half over half.
00:05:00.400 | So businesses, banks, they're trying to balance out the cycle and smooth out their earnings
00:05:05.440 | and their business numbers.
00:05:06.840 | So they're now lowering rates because they have more capacity.
00:05:10.040 | So the lesson here is just because the 10-year bond yield is going up, it doesn't mean the
00:05:15.680 | 30-year mortgage rate is going up in exact correlation.
00:05:20.080 | In fact, it could be flat or go down, which is why it's important to not only pay attention
00:05:25.280 | to the 10-year bond yield, but also to diligently check the latest mortgage rates when it comes
00:05:30.120 | time for you to refinance because, let's say, your arm is resetting or it's time for you
00:05:35.680 | to buy a house.
00:05:37.120 | Don't just rely on one indicator.
00:05:40.120 | You've got to diligently check and cross-reference.
00:05:43.480 | So the next question we should all ask is why is the average 15-year mortgage rate lower
00:05:48.160 | than the average 5-1 arm?
00:05:50.320 | I've been a big proponent of getting an arm over a 30-year fixed for a very, very long
00:05:55.040 | time because I believe interest rates are going to stay low for a very long time.
00:05:59.360 | You look back to mortgage rate trends since the late 1980s, and it's been coming down.
00:06:03.840 | And I think it's going to stay down because the market is much more efficient.
00:06:07.480 | We've got technology.
00:06:08.640 | We've learned through many cycles.
00:06:10.320 | Therefore, we have successfully tamed inflation.
00:06:13.600 | And therefore, there's no reason to really jack up interest rates.
00:06:18.200 | The reason why the average 15-year mortgage rate has been lower than the average 5-1 arm
00:06:23.760 | rate is because we're still in times of great uncertainty.
00:06:27.360 | Banks are still being cautious about the amount of money they lend, the duration of each loan,
00:06:32.980 | and who they lend money to.
00:06:34.480 | Yes, it's better than the first half of 2020, but still, banks are quite cautious.
00:06:40.440 | From a bank's perspective, a 15-year fixed rate mortgage is less risky because the bank
00:06:45.640 | gets paid back a larger amount each month in a shorter period of time.
00:06:50.040 | It's a 15-year amortizing loan versus a 30-year amortizing loan.
00:06:55.040 | At the same time, borrower demand for 30-year amortizing loans, which are 30-year fixed
00:07:00.600 | rate mortgages and arms, is higher because borrowers want maximum flexibility and lower
00:07:06.120 | monthly payments during times of uncertainty.
00:07:09.240 | So with higher borrower demand for a 30-year amortizing loan, banks can logically charge
00:07:14.540 | higher spreads to earn a higher risk-adjusted profit.
00:07:18.480 | Therefore, to entice mortgage borrowers to get a 15-year fixed rate mortgage, banks are
00:07:23.840 | willing to charge a lower spread and therefore a lower mortgage rate.
00:07:28.320 | For those of you looking to refinance or buy a home in the wintertime or in the upcoming
00:07:32.840 | months, if you can get a lower mortgage rate and pay down your mortgage quicker, it's not
00:07:38.560 | a bad idea.
00:07:39.960 | This is especially true if you're like me and regularly pay down extra principal anyway.
00:07:44.520 | The cash flow is not that big of a deal.
00:07:47.240 | As a homeowner, you're really optimizing for the lowest interest rate possible.
00:07:52.120 | Just make sure that before you do take out a 15-year fixed rate mortgage, you can comfortably
00:07:56.460 | afford the higher mortgage payments due to a shorter amortization period.
00:08:01.060 | My 30/30/3 home buying rule dictates that you should spend no more than 30% of your
00:08:05.240 | monthly gross income on your living expenses.
00:08:08.400 | Therefore, if you can do that, you should be good to go.
00:08:11.540 | So if you are in for a mortgage right now, the action step to take is to check online.
00:08:17.460 | You can go to financialsamurai.com/credible to get free real mortgage rate quotes.
00:08:24.060 | And you should go and talk to your banker.
00:08:25.940 | Shoot him or her an email or give them a call and ask what are the mortgage rates for 30-year
00:08:31.340 | fixed, 15-year arm, and various arm products.
00:08:35.500 | Hopefully you will find that the 15-year mortgage rate is lower than all others.
00:08:40.540 | I would probably go with that rate right now.
00:08:43.720 | It is the lowest rate with the widest spread I've ever seen.
00:08:47.380 | And I think you're going to feel good getting that lowest rate and paying off your mortgage
00:08:51.980 | quicker.
00:08:52.980 | I've never regretted paying off my mortgage and I don't think you will either.
00:08:56.540 | The next step is to think about the future.
00:08:58.060 | If you're not looking to refinance or buy a home now, you've got to think about where
00:09:02.940 | you think mortgage rates will go.
00:09:05.260 | I personally do not believe that mortgage rates will skyrocket or increase much further
00:09:09.980 | than where we are right now, especially as we go into winter and the coronavirus count
00:09:14.820 | ticks up and lockdowns start happening nationwide.
00:09:18.140 | I truly do believe there's going to be more lockdowns over the next two or three months.
00:09:22.700 | The vaccine, although phenomenal news, is not going to be available until what, April
00:09:27.860 | or May or maybe later.
00:09:29.500 | So you just can't really count on that.
00:09:31.580 | But in the meantime, I think a lot of people are just getting a lot more relaxed.
00:09:35.100 | And as a result, the case counts are just going out of control again.
00:09:38.580 | And it's going to breach the records we saw this summer, unfortunately.
00:09:42.460 | However, after the first quarter of 2021, things are probably going to start feeling
00:09:47.220 | a little bit better.
00:09:48.540 | We've gone through the worst of winter and there will have probably been a massive amount
00:09:53.160 | of positive vaccine news from all sorts of companies.
00:09:56.540 | And if they can't get it right, well, I mean, Pfizer can just, I'm assuming, give their
00:10:01.860 | formula to other vaccine manufacturers and help them pump out large quantities for the
00:10:06.700 | entire population.
00:10:08.460 | And therefore, we could enter a scenario where there is a raging bull market in 2021.
00:10:14.660 | Goldman Sachs, for example, is incredibly bullish on the future.
00:10:18.040 | They have a year-end target for 2020 of $3,700.
00:10:21.620 | That's an upgrade from $3,600.
00:10:23.580 | And they have a year-end 2021 target of $4,300 for the S&P 500.
00:10:28.540 | Now that's a 20% rise from current levels.
00:10:31.420 | So the S&P 500 does indeed go up by 20% from here.
00:10:36.260 | I am pretty sure mortgage rates are going to take higher.
00:10:39.180 | I don't think they're going to go way higher.
00:10:41.620 | But instead of seeing a 2.85% 30-year fixed rate mortgage, you might see a 3.875%.
00:10:49.560 | Not bad, but it's still relatively higher than it is right now.
00:10:52.860 | Therefore, if you are very bullish about the economy in 2021, you should probably refinance
00:10:58.740 | now because rates are probably going to go higher.
00:11:02.180 | And higher rates isn't necessarily bad at all.
00:11:04.880 | I'm sure we'd all gladly accept higher mortgage rates if our stock portfolios and real estate
00:11:10.580 | holdings both rise by another 10% to 20%.
00:11:14.700 | I know I would.
00:11:15.700 | But wouldn't it be even better to lock in lower mortgage rates today and then see our
00:11:21.780 | investments increase so much in value as well?
00:11:24.700 | I certainly would prefer the latter.
00:11:26.580 | Whatever happens, I'm thankful we all have options.
00:11:29.900 | We have an option to choose a 15-year fixed rate mortgage because it's currently trading
00:11:34.140 | way below average.
00:11:35.900 | I'm also thankful that the average 30-year fixed rate mortgage isn't going up as quickly
00:11:41.860 | as the 10-year bond yield.
00:11:44.020 | And I'm also really thankful that there's vaccine news.
00:11:46.660 | Oh my goodness, Pfizer coming out with a 90% efficacy.
00:11:50.780 | That compares really favorably to the flu shot vaccine, which has something like a 50%
00:11:54.820 | to 60% efficacy rate.
00:11:56.860 | And the FDA approval minimum rate is 50%.
00:11:59.860 | So 90% is just hitting a grand slam.
00:12:03.580 | It is great.
00:12:05.300 | And hopefully you're going to see more news from Marderna, Eli Lilly, and a whole bunch
00:12:09.360 | of other vaccine companies.
00:12:11.780 | So things are looking up.
00:12:13.620 | The stock market is doing well.
00:12:15.920 | Rates continue to stay low, although they're inching higher.
00:12:19.540 | Real estate continuing to do well.
00:12:21.820 | But we've got to buckle down this winter so we could live long enough and survive long
00:12:26.580 | enough to get these vaccines, these safe vaccines, hopefully.
00:12:30.180 | So before the lockdowns occur, I suggest going for a walk, going to the parks, going to the
00:12:35.340 | outdoors, playing some sports, and staying safe, because it could be a long winter.
00:12:40.540 | But I'm prepared.
00:12:41.540 | And hopefully all of us are prepared, and good things will happen in the future.
00:12:45.500 | Thanks so much, everyone, for listening.
00:12:46.940 | If you want to discuss more about mortgage market abnormalities, come hop over to the
00:12:51.820 | post.
00:12:52.820 | I've got a couple of cool charts, and we can discuss the future, mortgage rates, stock
00:12:57.460 | market, whatever you want.
00:12:58.780 | And if you found value in this episode, please, I'd love a positive review.
00:13:03.020 | It keeps me motivated and helps keep me going.
00:13:05.980 | I think the last time recorded was more than 20 days ago, because I've just been focusing
00:13:11.220 | on other stuff.
00:13:12.220 | But the more positive reviews I get, the more I'll record, and the more I'll invite my wife
00:13:16.420 | to talk about interesting subjects that can help us all.
00:13:20.020 | Stay safe, everyone.