Mortgage Rate Trends: Prime Time to Refinance
We reviewed 48 years of mortgage rates from Freddie Mac's Primary Mortgage Market Survey to understand key mortgage questions such as 'Is now a good time to refi?' and 'What type of mortgage should I get?'. Current mortgage rate trends are indicating it's a good time to refi with lower rates not seen since 2016. It's also a good time for the 30-year fixed mortgage - it's 'cheap' due to low rates and a small spread between the fixed and the ARM.
It's Prime Time to Refinance
Thought mortgage rates couldn't get any lower? Think again. Rates rose in late 2017 and for much of 2018. They neared 5% last November. But in 2019, rates plummeted again, from 4.51% at the beginning of the year down to 3.69% today. That's a 17% decline over the past ten months with the current rate lower than 2017 and 2018 rates. If you financed or refinanced your home recently while interest rates were higher, it might be a good time to refinance. We calculated the savings in a scenario for a $320,000 home loan at the then 30-year fixed rate of 4.51% in January 2019 and then later the remaining loan balance of 316,157 in October with a new 30-year fixed mortgage at 3.69%. Excluding fees, insurance, and taxes, the monthly payment fell from $1,623 to $1,453. That's a monthly savings of $170. Including the additional ten months of the mortgage term added with a refinance, the total savings over the 30-year loan term would be $44,640.
30-Year Fixed Rates Are Cheap Compared to ARM rates
The difference, or spread, between an adjustable rate mortgage (ARM) and a fixed-rate mortgage is essentially the 'cost' you pay to lock in your rate over 30 years. The lower ARM interest rate than a fixed rate compensates potential borrowers for taking on the risk of increased future interest rates after the initial fixed term (remember, you can refi in lower rate environments). In September, the ARM spread hit a low of 0.19% and has rebounded slightly to the current spread at 0.34%. Spreads seen in the last five months haven't been seen since 2009 during the financial crisis. In dollars and cents, for a loan value of $320,000, today's historically lower spread of 0.34% means an ARM would only give a prospective borrower monthly savings of $61 per month or $732 annually. The average spread since 2010 has been 0.88%, translating to ARM monthly savings of $154 or $1,848 annually. With 30-year fixed mortgage rates at 3.69%, near the historic low since 1971, and relatively little savings to be had with an ARM, now is a good time for a 30-year fixed.
Historical Mortgage Rates From 1971 to Today
Freddie Mac's Primary Mortgage Market Survey charts tell a story of the overall economy. Through the swoon of the "Great Inflation," during the late '70s and into the early '80s, mortgage rates ballooned. For 30-year fixed mortgages, they reached a precipice of 18.63% in October 1981 before generally declining over the next thirty years to a low of 3.31% in November 2012. Primarily due to static growth worldwide, a 30-year fixed mortgage interest rate today stands near the historic low at 3.69%. Numerous market variables have steered rates to this downward trend.
Drivers of Mortgage Rates over Time
Although mortgage rates are less choppy than the stock market, rates do change over time. Certain economic drivers and government fiscal policies pressure them to move upward or downward, following an overall supply and demand cycle. Some of the things that impact mortgage rates include:
Increased money circulation raises prices, which erodes consumers' purchasing power. Lenders monitor inflation to offer a competitive mortgage rate while generating a return profit. If mortgage rates are 4% and inflation is 2%, then lenders will see a 2% return.
With inflation, Gross Domestic Product (or GDP) and employment rates are general indicators of the nation's growth. Greater household income leads to upswings in home buying — and with it higher interest rates. But elevated mortgage rates require more income to purchase a home. In a sluggish economy, rates dip to attract buyers.
Federal Reserve Monetary Policy
As the economy's central piston, the Federal Reserve Bank sets the Federal Funds Rate, the interest rate at which banks and other depository institutions lend money to each other. This rate is used to control inflation and is the barometer by which short-term lending rates are set. If the Fed Funds Rate is raised, it restricts the money supply and mortgage rates will increase, which makes qualifying for a loan more difficult. If the rate is lowered, easing the money supply, short-term rates will fall accordingly.
The Bond Market
Earned interest rates and securities pricing on the bond market also cause mortgage rates to fluctuate. Lending rates frequently adjust based on the government issued, 10-year Treasury bond yield.
Another contingent is securitized mortgages pricing, known as mortgage-backed securities or MBS, which inversely affects rates. Kevin Leibowitz, owner of Grayton Mortgage, who structured and traded mortgage-backed securities at Deutsche Bank, Bear Stearns and Countrywide, explains: "Mortgages get pooled into MBS that get purchased by investors. So, demand for these securities drives rates. The greater the investor demand, the higher the prices for these securities, and as a result, lower interest rates for borrowers."
Lastly, of course housing market conditions factor into rate adjustments. If fewer homes are being sold or offered for resale, then financial establishments will scale-back their rates. And if consumer trends point to renting over buying a home, then rates will fall to entice buyers.
Different Kinds of Mortgages
Fixed-Rate vs. Adjustable-Rate Mortgages
Lenders use these market indicators to calculate rates, which are then offered in different kinds of loans: fixed-rate, adjustable rate or interest-only loans.
With a fixed-rate mortgage, the interest rate is locked for the life of the loan, protecting borrowers from adjusted rate hikes. Lending institutions frequently use the interest earned on a 10-year Treasury bond to arrive at mortgage rate pricing for fixed-rate loans. Borrowers can choose among 30-, 20-, or 15-year terms, each with varying interest rates. The conventional 30-year fixed offers borrowers the lowest monthly premium with an extended amortization period. The tradeoff, however, is a higher interest rate and a higher total cost of your mortgage due to the interest rate and length of the loan.
The 15-year fixed mortgage rate is currently 3.05% and the trend of rates mirrors the 30-year fixed rates, except that they are lower. Similar to the 30-year, 15-year fixed rates haven't been this low since 2016 but aren't yet as low as the historic low in 2013 of 2.56%. The spread between 30- and 15-year mortgages is less volatile than the 30-year to ARM spread and is currently 0.52% which is close to the average spread since 1991 of 0.56%. Using the current mortgage rates the table below shows the dollars and cents comparison of the 30- and 15-year mortgages if financing a $320,000 loan.
Interest rate (%)
Total cost of mortgage
See For Yourself
Adjustable rate mortgages (ARM)
Less common than fixed-rate mortgages, adjustable rate mortgages are more complicated. ARM rates are calculated using a set of variables after an initial fixed period on the loan. The initial period can vary from one month to 10 years, but are usually offered in 3-, 5- or 7-year fixed installments. Currently, a 5/1 ARM is pegged at 3.35% versus 3.69% for a 30-year fixed-rate mortgage.
the 5/1 ARM rate has been reported by Freddie Mac since 2005. The trend of the ARM rates closely follow the 30-year fixed rates, except for the noted spread differences. Spreads change due to the different periods of guaranteed rates on each loan and the way the debt markets value these different guaranteed rate periods (thirty versus five).
Once the fixed-term expires on an ARM, lenders apply an adjustment index and a margin to the new rate. The index is the referenced financial benchmark, such as the 10-year Treasury note. The margin is the contractual percentage paid on top of the index. The margin, for example, may be the 10-year Treasury note plus 2%. Also, caps are applied, which puts a limit on interest rates between resets. A ceiling is also added to the loan, putting a limit on how high the interest rate can go over the loan's lifetime.
Borrowers could easily take advantage of low rates through loan's life cycle, depending on going market rates. These mortgages are best suited for buyers expecting an income bump or those who plan on selling the home. Kevin cautions, "I suggest that a borrower only gets an ARM if they know that there is a finite amount of time they will be at that property ... then an ARM might make perfect sense. Or, if a borrower thinks that they will pay down a significant amount of the balance of the mortgage ... ”
Interest-only loans allow home buyers to defer the loan's principal to future installments. Interest is paid for a fixed schedule, structured as 3/1, 5/1, 7/1 or 10/1 loans like an ARM. The loan then converts to include principal and interest. The initial rate is equal to the fixed-rate period of ARM loans.
First-time buyers like the fixed low interest rate. This mortgage options, has similar risks to ARMs. James McGrath, Co-Owner of Yoreevo brokerage firm and former financial analyst at Citadel advises, "While the product itself is not inherently any riskier, it does encourage risky behavior."
An interest-only mortgage loan allows buyers to stretch their finances to potentially buy a larger, more expensive home than they would otherwise be able to afford, he says. It also takes away the idea of "forced savings" by paying down the mortgage, which appeals to a lot of buyers. Most homeowners want to slowly build equity and eventually own their home outright, McGrath says.
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