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Mortgage rates are near record lows, but they are not as low as they should be.
Based on how much the yield on mortgage bonds have fallen in recent months, lenders could offer mortgage borrowers much better deals if they wanted to. But when faced with the option to offer the best deal possible to borrowers or increase profits, what do you think lenders prefer? You guessed it.
Historically, mortgage rates have followed the same direction as the yields on mortgage bonds. But lately, mortgage rates have not been dropping as much, or at the same pace as mortgage bonds.
"In my view, rates are about 50 basis points higher than they should be," says Cameron Findlay, chief economist for Discover Home Loans.
That means borrowers are getting 30-year mortgages at 3.5 percent, when they really should be getting a rate closer to 3 percent.
Lenders have been able to maintain higher rates -- compared to bond yields -- because they have enough demand from mortgage borrowers, Findlay says. Even at a slightly higher level, consumers are getting some of the lowest interest rates in history, and that's enough to attract borrowers. In other words, with rates so low, lenders don't have to offer the lowest rate possible to attract refinancers, he says.
Why mortgage bonds matter
Usually, the higher the rate on the mortgage and the lower the yield on mortgage bonds, the more money lenders make. That's because after the mortgages are issued, the loan originator packages and sells the loans as bonds.
The gap between bond yields and the actual rate borrowers get on their mortgages has surged in recent months, as have lenders' profits. That gap is known in the industry as the spread between yields and rates.
This gives you an idea of how that spread is increasing: In early May, the spread between the rate on the 30-year fixed mortgage and the yield on the 30-year Freddie bond was about 0.69 of a percentage point, according to Bankrate's weekly survey.
The spread reached 1.15 percentage points last week when the 30-year fixed rate in Bankrate's survey was 3.81 percent and Freddie's yield was 2.66 percent.
"Rates are definitely not declining as fast as bond yields," Findlay says.
It's supply and demand. They have demand at the current price, so why not milk it for what it's worth? When the demand dries up, or slows down, then they'll drop the rate a little more to tease the holdovers.
It's business at its finest, and I see no issue here, if people are willing to pay the price for something.