Decreased Investor Appetite Sends Rates Higher - 5.31.2023

by Ryan Schoen , Sr. Insight Analyst

Quick Hit Summary for Loan Officers

The spread between the 30-year mortgage rate and 10-year treasury has exploded to the north of 3% for the first time since the financial crisis as investors reprice risk assets and demand for mortgage-backed securities evaporates. This development is causing mortgage rates to spike, mortgage application demand to remain suppressed, and renting to become preferred over buying.

Key Points and Stats

1. 30-year fixed mortgage rates have risen to around the 7% mark representing the highest levels since November 2022.
2. Purchase applications are down 31% and Refinance applications are down 45% from the same week one year ago.
3. Despite annual home price growth falling faster than rent prices for the vast majority of the country, rising mortgage rates mean that only a handful of markets in the South are showing signs that buying makes more financial sense than renting from a pure monthly cost standpoint.

Debt Ceiling and Mortgage Rates

The House and Senate are under pressure this week to pass a debt ceiling bill before the June 5th deadline (when the government is anticipated to run out of cash) to avoid default. Over the weekend President Biden and Speaker Kevin McCarthy reached an agreement in principle to suspend the debt ceiling until January 1, 2025, after the next presidential election. The uncertainty surrounding the bill has led to volatility in the market sending interest rates higher as market participants reprice risk assets.

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As for the impact on mortgage rates, this developing story has added significant pressure on investors’ appetite for mortgage-backed securities (which mortgage rates are priced from) and the risk premium that investors are willing to accept. The recent news is compounding the problems the industry faces as MBS demand is already facing headwinds due to the Federal Reserve suspending its purchase of MBS and financial institutions stepping back from committing capital to longer duration assets after seeing recent bank failures directly related to holding assets that go down in value (at least on paper) as interest rates rise.

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These headwinds have caused the spread of 30-year mortgage rates to 10-year mortgage rates to spike to levels not seen since the great financial crisis. Typically, the spread between the two hovers around the 2% mark, but today that spread has exploded to north of 3%. The uncertainty surrounding the direction of interest rates is unlikely to abate anytime soon leaving investors stuck between a rock and a hard place. When interest rates drop homeowners, refinance leaves investors no longer holding an old mortgage with a high-interest rate which means they are left with cash that must be reinvested at the new low-interest rate. When interest rates rise investors also have the problem of being stuck with an old low-interest-rate mortgage that nobody will payoff leaving investors waiting to get their cash back so that they can reinvest and buy new higher interest-paying mortgages. Since there is a dilemma to both rising and falling interest rates what investors want is stability. Until there is stability in the market the spread will not narrow, and we will likely continue to see higher mortgage rates than we typically should.

Rising Mortgage Rates Hurt Mortgage Application Demand

In concert with rising mortgage rates, mortgage applications continue to flounder. Overall demand for mortgage applications remains at historic lows regardless of loan purpose.

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The latest purchase mortgage application index data revealed a decrease of 3% on a week-over-week basis and sat 31% lower than the same week one year ago as purchase volume remains constrained by a lack of homes on the market and deteriorating affordability. The latest refinance application index came in down 7% lower week-over-week and 45% lower than the same week one year ago as current homeowners have little to no incentive to move on from their existing loan. With inflation still running high and recent economic data showing little signs of a slow down investors are starting to believe that the Fed will not be pausing or cutting rates anytime soon which means more of the same depressed application levels can be expected.

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The survey, which covers approximately 75% of all U.S. retail residential mortgage applications, came in with an average contract interest rate for a 30-year fixed-rate mortgage on conforming loans of 6.91% representing the highest level since November 2022. From a loan product standpoint, FHA accounted for 12.7% of all loan applications, VA accounted for 12.1%, and USDA 0.5%. Additionally, refinance accounted for 1 in 4 applications and adjustable-rate mortgages came in at a 6.8% share.

Home vs Rent Prices

The rising rate environment is doing its job for the most part to cool off shelter costs as home and rent prices continue to slow on a year-over-year basis.

However, despite home prices falling faster than rent prices the actual trade-off calculation between the two options favors renting across most of the country as rising mortgage rates more than offset any potential affordability improvement in purchasing a home over renting. Looking at the largest metro areas based on population size, only Chicago and Pittsburg favor buying a home over renting on a monthly cost basis and only San Francisco has an annual mortgage cost growth rate lower than the cost to rent.

For homebuyers that are considering their options outside the largest metro areas Southern markets are where it makes the most sense to buy over rent.

Yet, even when it makes more sense to buy than to rent, it’s worth noting that doing so will come at a historically high premium. If we remove interest rates as a variable and the cost of a mortgage from the equation and simply look at the purchase price of a home compared to the annual price to rent, we see that nationally would-be homebuyers are currently being asked to pay a 10.6% premium over renting. That figure balloons to 20.9% for McAllen, TX (the highest among the top 100 largest metro areas). These figures indicate just how much further home prices could need to fall to align with longer-standing local market trends based on the relationship between home and rent prices.

Resources:

1. Interest Rates?

2. Mortgage Applications?

3. Home vs Rent Prices