Hello, everybody. It's Sam from Financial Samurai. And in this episode, I want to talk about the mortgage market and specifically mortgage market abnormalities. The number one economic indicator or financial indicator I like to track is the 10-year bond yield. The 10-year bond yield tells you a lot of things.

You can write books about what the 10-year bond yield is saying. And after the election results on November 7, we saw that the 10-year bond yield spiked higher to about 0.97%. But in actuality, the 10-year bond yield has been rising steadily from a bottom of around 0.51% in early August to about 0.85% up until the election results.

And concurrently, what's been happening is that the average 30-year mortgage rate has been going down while that 10-year bond yield had been going up. At first, I was thinking to myself, this must be a mortgage market anomaly. You know, there's a kink in the system. It'll right itself eventually.

But after about three months of this disconnect, it's clear that something's going on with the 30-year fixed-rate mortgage. And we need to get to the bottom of it. The other mortgage market anomaly is that the average 15-year mortgage rate is way below the average 5.1 arm rate. We're talking 50 basis points or a half a percentage points lower than the 5.1 average rate.

And this generally doesn't happen because longer-term duration loans charge higher rates. It's just like if your buddy were to ask you to borrow $20 and if he pays you back tomorrow, you won't charge him an interest rate. But if he says, I want to borrow $100,000, which you're probably not going to lend him over a 30-year period of time, you're certainly going to demand a higher rate because inflation is going to eat up the value of the dollar.

So based on the time value of money, longer-term duration loans charge higher rates. And with the 15-year fixed, generally, a 15-year fixed mortgage is more expensive than a 5.1 arm or a 7.1 arm or a 10.1 arm, right? Because the arms are shorter duration loans. So the question the intellectually curious should ask is, why did the average 30-year fixed rate decline when bond yields went up?

The simple answer is that banks were more able to lend once they got through a tremendous refinance backlog and hired more people. When the pandemic hit in March 2020, lending standards tightened tremendously. A lot of the bankers were thinking, uh-oh, this is back to 2008, 2009 financial crisis. Our loan book is going to get hit.

There's going to be defaults and so forth. So the lenders and the underwriters were like, well, OK, we're going to take our time. We're only going to lend to the highest credit-worthy borrowers. And refinances took weeks, if not months, longer than normal to close. About a month after the lockdowns began, I got pre-approved for a mortgage.

But instead of taking one to two weeks, it took four-plus weeks. And it's just because things were all backlogged. At the same time, demand to refinance skyrocketed, given rates fell by over 1% in just one or two months. So many lenders found themselves short-staffed. And they began aggressively trying to hire to meet the increase in demand.

And so the finance industry is very cyclical in nature. It's kind of boom and bust. And you can never really time it right. And so managers are trying to smooth out the cycles by having the right amount of staff. But in this case, it was quite a shock. Given it takes time to hire people and train people to help dampen the demand volume, lenders decided to charge a higher spread over an index.

And that index is usually LIBOR. So instead of charging just 2% above LIBOR, lenders began charging 2.25% or 2.5% above LIBOR. This is all about demand management here. And by charging a higher spread, banks can therefore earn a higher profit margin on the loans that they do close. So banks that found themselves more undermanned than others rationally charged higher mortgage rates.

And as a result, consumers had to diligently shop around to get the best rate. So what's going on today? Well, lenders have more capacity to handle refinances and purchase loans because demand has subsided and more people are employed to handle the workload. I spoke to my mortgage officer the other day and he said those people who wanted to refinance have already refinanced.

And he said he was focusing more on purchase loans going into 2021 and beyond. So as a result, given more capacity, lenders are now charging lower spreads to help boost business once more. Again, it was a pull forward of a lot of refinancing earlier in 2020. And now 2020 second half compared to 2020 first half is looking pretty light.

It's probably going to be, I would think, down half over half. So businesses, banks, they're trying to balance out the cycle and smooth out their earnings and their business numbers. So they're now lowering rates because they have more capacity. So the lesson here is just because the 10-year bond yield is going up, it doesn't mean the 30-year mortgage rate is going up in exact correlation.

In fact, it could be flat or go down, which is why it's important to not only pay attention to the 10-year bond yield, but also to diligently check the latest mortgage rates when it comes time for you to refinance because, let's say, your arm is resetting or it's time for you to buy a house.

Don't just rely on one indicator. You've got to diligently check and cross-reference. So the next question we should all ask is why is the average 15-year mortgage rate lower than the average 5-1 arm? I've been a big proponent of getting an arm over a 30-year fixed for a very, very long time because I believe interest rates are going to stay low for a very long time.

You look back to mortgage rate trends since the late 1980s, and it's been coming down. And I think it's going to stay down because the market is much more efficient. We've got technology. We've learned through many cycles. Therefore, we have successfully tamed inflation. And therefore, there's no reason to really jack up interest rates.

The reason why the average 15-year mortgage rate has been lower than the average 5-1 arm rate is because we're still in times of great uncertainty. Banks are still being cautious about the amount of money they lend, the duration of each loan, and who they lend money to. Yes, it's better than the first half of 2020, but still, banks are quite cautious.

From a bank's perspective, a 15-year fixed rate mortgage is less risky because the bank gets paid back a larger amount each month in a shorter period of time. It's a 15-year amortizing loan versus a 30-year amortizing loan. At the same time, borrower demand for 30-year amortizing loans, which are 30-year fixed rate mortgages and arms, is higher because borrowers want maximum flexibility and lower monthly payments during times of uncertainty.

So with higher borrower demand for a 30-year amortizing loan, banks can logically charge higher spreads to earn a higher risk-adjusted profit. Therefore, to entice mortgage borrowers to get a 15-year fixed rate mortgage, banks are willing to charge a lower spread and therefore a lower mortgage rate. For those of you looking to refinance or buy a home in the wintertime or in the upcoming months, if you can get a lower mortgage rate and pay down your mortgage quicker, it's not a bad idea.

This is especially true if you're like me and regularly pay down extra principal anyway. The cash flow is not that big of a deal. As a homeowner, you're really optimizing for the lowest interest rate possible. Just make sure that before you do take out a 15-year fixed rate mortgage, you can comfortably afford the higher mortgage payments due to a shorter amortization period.

My 30/30/3 home buying rule dictates that you should spend no more than 30% of your monthly gross income on your living expenses. Therefore, if you can do that, you should be good to go. So if you are in for a mortgage right now, the action step to take is to check online.

You can go to financialsamurai.com/credible to get free real mortgage rate quotes. And you should go and talk to your banker. Shoot him or her an email or give them a call and ask what are the mortgage rates for 30-year fixed, 15-year arm, and various arm products. Hopefully you will find that the 15-year mortgage rate is lower than all others.

I would probably go with that rate right now. It is the lowest rate with the widest spread I've ever seen. And I think you're going to feel good getting that lowest rate and paying off your mortgage quicker. I've never regretted paying off my mortgage and I don't think you will either.

The next step is to think about the future. If you're not looking to refinance or buy a home now, you've got to think about where you think mortgage rates will go. I personally do not believe that mortgage rates will skyrocket or increase much further than where we are right now, especially as we go into winter and the coronavirus count ticks up and lockdowns start happening nationwide.

I truly do believe there's going to be more lockdowns over the next two or three months. The vaccine, although phenomenal news, is not going to be available until what, April or May or maybe later. So you just can't really count on that. But in the meantime, I think a lot of people are just getting a lot more relaxed.

And as a result, the case counts are just going out of control again. And it's going to breach the records we saw this summer, unfortunately. However, after the first quarter of 2021, things are probably going to start feeling a little bit better. We've gone through the worst of winter and there will have probably been a massive amount of positive vaccine news from all sorts of companies.

And if they can't get it right, well, I mean, Pfizer can just, I'm assuming, give their formula to other vaccine manufacturers and help them pump out large quantities for the entire population. And therefore, we could enter a scenario where there is a raging bull market in 2021. Goldman Sachs, for example, is incredibly bullish on the future.

They have a year-end target for 2020 of $3,700. That's an upgrade from $3,600. And they have a year-end 2021 target of $4,300 for the S&P 500. Now that's a 20% rise from current levels. So the S&P 500 does indeed go up by 20% from here. I am pretty sure mortgage rates are going to take higher.

I don't think they're going to go way higher. But instead of seeing a 2.85% 30-year fixed rate mortgage, you might see a 3.875%. Not bad, but it's still relatively higher than it is right now. Therefore, if you are very bullish about the economy in 2021, you should probably refinance now because rates are probably going to go higher.

And higher rates isn't necessarily bad at all. I'm sure we'd all gladly accept higher mortgage rates if our stock portfolios and real estate holdings both rise by another 10% to 20%. I know I would. But wouldn't it be even better to lock in lower mortgage rates today and then see our investments increase so much in value as well?

I certainly would prefer the latter. Whatever happens, I'm thankful we all have options. We have an option to choose a 15-year fixed rate mortgage because it's currently trading way below average. I'm also thankful that the average 30-year fixed rate mortgage isn't going up as quickly as the 10-year bond yield.

And I'm also really thankful that there's vaccine news. Oh my goodness, Pfizer coming out with a 90% efficacy. That compares really favorably to the flu shot vaccine, which has something like a 50% to 60% efficacy rate. And the FDA approval minimum rate is 50%. So 90% is just hitting a grand slam.

It is great. And hopefully you're going to see more news from Marderna, Eli Lilly, and a whole bunch of other vaccine companies. So things are looking up. The stock market is doing well. Rates continue to stay low, although they're inching higher. Real estate continuing to do well. But we've got to buckle down this winter so we could live long enough and survive long enough to get these vaccines, these safe vaccines, hopefully.

So before the lockdowns occur, I suggest going for a walk, going to the parks, going to the outdoors, playing some sports, and staying safe, because it could be a long winter. But I'm prepared. And hopefully all of us are prepared, and good things will happen in the future. Thanks so much, everyone, for listening.

If you want to discuss more about mortgage market abnormalities, come hop over to the post. I've got a couple of cool charts, and we can discuss the future, mortgage rates, stock market, whatever you want. And if you found value in this episode, please, I'd love a positive review. It keeps me motivated and helps keep me going.

I think the last time recorded was more than 20 days ago, because I've just been focusing on other stuff. But the more positive reviews I get, the more I'll record, and the more I'll invite my wife to talk about interesting subjects that can help us all. Stay safe, everyone.