A staggering 90 percent of home builders say the affordability of new properties is being hampered by rising lumber prices.
The finding came from the latest National Association of Home Builders/Wells Fargo Housing Market Index, where many builders claimed that the higher costs of construction are forcing more prospective buyers to back out of the new home market.
Builders say the main reason for the increased costs is the rise in lumber prices over the last one and a half years. Almost 95 percent of builders say the spike in the price of lumber was impacting the affordability of new homes, with respondents evenly split on whether it was having a “significant” or “minor” impact.
Prices of lumber in the U.S. have increased by 62 percent since President Donald Trump came into power in January 2017, the NAHB’s chief economist Robert Dietz said. He reckons that lumber tariffs have increased the price of the average new home by around $9,000.
Builders say the rising prices may be due to a widespread shortage of lumber. More than 30 percent of single-family home builders reported facing framing lumber shortages, which is the highest figure since the NAHB began tracking this data in 1994.
The problem of housing affordability isn’t just down to lumber prices however. A recent report in The Morning Call states that while lumber is a significant factor, labor shortages and growing regulations are also to blame.
According to the NAHB’s Dietz, homebuilding in many parts of the country is being held back due to a lack of workers, with almost 230,000 building jobs in the U.S. currently unfulfilled.
“Labor has been an issue of the industry for the last four or five years,” he said. “The job openings rate in the construction industry now is actually higher than it was at the peak of the building boom.”
Then there’s the problem of increased building regulations and stricter zoning requirements, which result in both fewer starts and increased costs. Dietz said that regulations add up to around a quarter of the cost of a median-priced home, and more than 30 percent of the cost of an apartment. These costs also restrict builder’s ability to produce homes at the lower-end of the market, which is the price point targeted by most younger buyers.
Mike Wheatley is the senior editor at Realty Biz News. Got a real estate related news article you wish to share, contact Mike at [email protected].
The average U.S. mortgage rate for a 30-year fixed loan is 2.88% this week, falling from last week’s 2.9%, Freddie Mac said in a report on Thursday. The rate is now two basis points from an all-time low set three weeks ago.
The average fixed rate for a 15-year mortgage was 2.36%, falling from last week’s 2.4% to a level that’s one basis point away from the record 2.35% set two weeks ago, the mortgage giant said.
It was the tenth consecutive week average mortgage rates have been below 3%, boosting demand for homes and driving up prices, said Sam Khater, Freddie Mac’s chief economist.
“As a result of low mortgage rates that have stayed under three percent since July, the housing market has seen a strong, upward trajectory during a very uncertain time,” said Khater. “We’re seeing potential homebuyers who now have more purchasing power.”
Pending home sales, measuring signed contracts to purchase properties, soared 8.8% in August to a record high, the National Association of Realtors said in a report on Wednesday.
“Tremendously low mortgage rates – below 3% – have again helped pending home sales climb in August,” said Lawrence Yun, NAR’s chief economist. “Additionally, the Fed intends to hold short-term fed funds rates near 0% for the foreseeable future, which should in the absence of inflationary pressure keep mortgage rates low, and that will undoubtedly aid homebuyers continuing to enter the marketplace.”
The housing market typically plays a counter-cyclical role during recessions because economic slowdowns tend to push mortgage rates lower, Yun said. However, this time surpassed his expectations, he said.
“While I did very much expect the housing sector to be stable during the pandemic-induced economic shutdowns, I am pleasantly surprised to see the industry bounce back so strongly and so quickly,” Yun said.
In March, the Federal Reserve started buying bonds – Treasuries and mortgage-backed securities – to prevent a credit crunch and make borrowing cheaper. Since then, the central bank has bought about $1 trillion of bonds backed by home loans, according to Fed data.
Of the total number, 69.3% of borrowers remained in forbearance plans in July because of the pandemic, 6.5% were in forbearance because of a natural disaster, while the remaining 24.2% cited other reasons such as temporary hardship caused by job loss, death, divorce, disability, etc.
MBA’s report showed that the share of Ginnie Mae loans in forbearance fell from 0.93% in June to 0.80% in July. The percentage of Fannie Mae and Freddie Mac loans in forbearance inched down one basis point month over month to 0.20%, and the share of portfolio and private-label securities (PLS) loans in forbearance decreased seven basis points to 0.45%.
“The prevalence of forbearance plans has dramatically dropped since 2020, and the reasons that borrowers are in forbearance are changing,” said Marina Walsh, MBA’s vice president of industry analysis. “About two-thirds of borrowers are still in forbearance because of the effects of COVID-19, but a growing share of borrowers are in forbearance for other reasons that cause temporary hardship such as financial distress or natural disasters.”
While Fannie Mae and Freddie Mac have ended certain COVID-19 forbearance plans and workouts, the government-sponsored enterprises offer mortgage assistance and disaster relief options, especially for homeowners and renters affected by the ongoing wildfires in Hawaii.
“Given the recent natural disasters impacting California, Washington, and Hawaii, forbearance is one way for mortgage servicers to mitigate the potential impacts on homeowners,” Walsh said.
A trio of reports released today by Redfin and Zillow revealed some rather conflicting information about the housing market.
While pretty much everyone agrees that were back on the right track, albeit tenuously, new data from Redfin reveals a spring slowdown in housing.
The online real estate listing service noted that home sales in Redfin’s 11 West Coast markets slipped 13.4% last month compared to a year earlier, marking a five-year low.
No, It’s Not the Weather…
We can’t blame the weather this time around because the notoriously warm West Coast performed worse than the rest of the nation.
In fact, home sales in Redfin’s other markets were down only 5.9% in February from a year earlier.
The hardest-hit metro was Las Vegas, where home sales in February were down 22.7% from a year ago. Sacramento, CA (-21.8%) and Ventura, CA (-20.8%) weren’t far behind either.
Of course, these very metros saw home prices rise enormously over the past 12 months so the issue is actually diminishing affordability, with both mortgage rates and home prices significantly higher than a year ago.
Today, Freddie Mac reported that interest rates on the 30-year fixed mortgage averaged 4.37%, up from 3.63% a year ago.
You can refer to my mortgage payment charts to get an idea of the monthly increase on a rate rise like that based on loan amount.
Additionally, national home prices were up 1.2% in February from January and 13% higher than a year ago.
The West chalked high double-digit gains (19.1%), while the rest of the country managed more modest gains of 7.4%. Many parts of the East Coast weren’t nearly as strong with year-over-year gains of only 2% in Long Island, 4.7% in D.C., and 6.6% in Boston.
So maybe the cold weather is to blame on the East Coast, but not on the Left Coast.
When we consider mortgage rates 1% or so higher and home prices 10%+ higher, it’s understandable why home sales are down.
However, inventory is up big in Phoenix (38.5%), Sacramento (23.9%), Riverside (22.8%), Ventura (22.1%), San Diego (18.6%), and Los Angeles (17.8%) compared to a year ago, which makes you wonder if buyers and sellers just aren’t on the same page.
[Is it better to rent or buy a home?]
Four Million First-Time Buyers Want In This Year
After all, a different report released today by Zillow indicated that more than four million first-time home buyers want to purchase properties this year.
The company said 8% of all households and 10% of current renters indicated that they plan to buy a home in the next 12 months.
Renters in Atlanta, Las Vegas, and Miami were the most eager to become homeowners in 2014.
If all the renters that told Zillow they plan to buy actually come through, it would represent more than 4.2 million first-time sales this year, roughly double the 2.1 million seen in 2013.
Additionally, an overwhelming share (90%+) of renters in 17 of 20 metros that indicated plans to buy said they were “confident” or “somewhat confident” they could afford a home.
So it’s unclear if affordability is actually the concern. It could just be that these individuals aren’t as willing to buy if home sellers don’t list their homes more reasonably.
The next couple months will be telling in terms of which way the market goes.
Redfin already expects March to be soft, with offers and home tours both down from year-ago levels, so something clearly isn’t right.
And Redfin was quick to point out that it’s data is the most current, with information collected just minutes after a sale, pending sale or listing activation.
Read more: Somewhere between a buyer’s and seller’s market.
Don’t call it a comeback, Good demographics and low mortgage rates have been here for years, Rockin’ the bubble boys Puttin’ the bears in fear
That’s a reference to the song “Mama Said Knock You Out” from L.L Cool J. I have used this in other articles and interviews, which runs in line with my big macro take that what drives the housing market are mortgage rates and demographics. So, you shouldn’t be surprised about what I am writing today.
Today, purchase application data confirmed what I needed to see to justify that we should get a positive total existing-home sales year in 2020. Yes, as crazy as it sounds, we can do this for the existing home sales market in 2020.
I wanted to see at least 20 straight weeks of double-digit year-over-year growth on average to make up for the nine negative weeks we saw due to COVID-19. Those nine negative weeks came at a crucial time for the MBA purchase application data as it was right in the data line’s heat months. So, we had a lot of work to do to get back to the point where we can go positive, but it happened.
The MBA report shows the year-over-year growth for the last eight weeks has been +21%, +22%,+25%,+6%, +40%,+28% +33% and +27%. As you can see in the chart, these last eight weeks have created enough demand to move the total volumes higher than we would see during the heat months, which is during the second week of January to the first week of May. Since this data looks out 30-90 days, it’s enough demand to help the existing home sales market, which is still a negative year to date, to be positive for the year. The only thing that can stop this is some non-economic events at this stage since we are in October.
Also, throwing this out there. What happened to the ‘we have no homes to buy’ crowd, and the idea that credit is getting too tight? It looks like credit is getting tighter on the surface, and that we have no homes to buy. However, both ideas are incorrect, as I have been talking about all year. Once demand picks up, sales will pick as we have plenty of homes to buy to get sales back positive. I have also tried my best all year to try to debunk the tight credit thesis, which is a common fairy tale these days. More on that here.
While the Bubble Boys were talking smack that we were in trouble and the Forbearance Crash Bros were snarling at us, king demographics and low mortgage rates showed these kids who was really in charge. However, jobs are not done; let’s get 2020 into positive territory to show these overrated rookies who are the real bosses.
A bipartisan energy bill that was introduced to the Senate late last month would benefit mortgage borrowers who buy or refinance energy-efficient homes.
The SAVE Act, co-authored by U.S. Senators Michael Bennet (D-CO) and Senator Johnny Isakson (R-GA), would allow federal mortgage agencies to consider a property’s energy efficiency and expected energy bills when determining a homeowner’s ability to repay their mortgage.
Energy Reports Become Part of the Mortgage Underwriting Process
When applying for a federally backed loan, such as an FHA loan, VA loan, or Fannie Mae/Freddie Mac loan, the borrower would have the voluntary option to submit a so-called energy report.
From this report, lenders would determine the energy savings associated with any green fixtures, such as energy-efficient appliances, windows and insulation, or solar panels, and compare them to average energy costs for similar homes in the area.
Those savings could then be used to offset other monthly liabilities when determining the borrower’s debt-to-income ratio, thereby giving the consumer more purchasing power.
It could also mean the difference between an approval and a denial if the borrower’s DTI was right on the cusp, particularly important with the new Qualified Mortgage rules.
Additionally, lenders would be able to factor in the present value of energy savings into the value of the home when calculating the loan-to-value ratio.
So if a home came equipped with solar panels or some other energy-savings upgrades, they could actually lower the LTV, and potentially push a loan below key thresholds.
For example, a lender could add energy upgrades to a home’s value to push the LTV down to 80% or lower to help a borrower avoid private mortgage insurance.
Lenders would also be required to inform loan applicants about the benefits of energy efficiencies and the resources available to them.
Additionally, the legislation would allow homeowners to finance energy upgrades into their mortgages.
Homeowners Spend $70,000 on Energy Costs During 30-Year Mortgage Term
The lawmakers claim the average homeowner spends $2,500 in energy costs annually, or a whopping $70,000 during a 30-year mortgage term.
Energy efficiency upgrades can lower these costs by 30% or more, putting cash in the pockets of homeowners that could even go toward paying down the mortgage earlier.
Last year, a study conducted by the University of North Carolina at Chapel Hill (UNC) Center for Community Capital and the Institute for Market Transformation (IMT) found that owners of energy-efficient homes were about a third less likely to miss their mortgage payments.
The author of the study argued that green homeowners could be entitled to lower mortgage rates, further increasing their purchasing power.
If passed, the SAVE Act could result in energy savings of $1.1 billion, which in turn would be funneled back into the economy.
Investment in energy-efficient home building also has the potential to create an estimated 83,000 construction jobs.
During the initial wave of the banking crisis in March, I published “Truist: Immense Unrealized Bond Losses Threaten Core Equity Stability.” At the time, Trust Financial Corp. (NYSE:TFC) had suffered the most significant drawdown among the top-ten US banks. Roughly five months ago, I was among the few analysts with a definitively bearish outlook on the bank, while many had viewed it as a dip-buying opportunity. My perspective was that although TFC’s “bank run” risk was low, the vast extent of its off-balance sheet losses left it with little safety for a potential rise in loan losses. Further, I expected that growing net interest margin pressures would substantially lower the bank’s income over the coming year, potentially compounding its risks.
Since then, TFC has declined by an additional ~11% in value and recently retraced back near its May bottom, associated with the failure of the Federal Republic. I believe the most recent wave of downside in at-risk banks is a notable signal that the market continues to underestimate systemic US financial system risks. Of course, following TFC’s most recent bearish pattern, I expect many investors to increase their position, viewing the company as significantly discounted. Accordingly, I believe it is an excellent time to take a closer look at the firm to estimate better its discount potential or the probability of Truist facing much more significant strains.
Estimating Truist’s Price-to-NAV
On the surface, TFC appears to have considerable discount potential. The stock’s TTM “P/E” is 6.3X compared to a sector median of 8.7X. Its forward “P/E” of 7.7X is also below the banking sector’s median of 9.3X. TFC’s dividend yield is currently at 7.2%, nearly twice as much as the sector median of 3.7%. Finally, its price-to-book is 0.66X, considerably lower than the sector median of 1.05X. Based on these more surface-level valuation metrics, TFC appears to be around trading around a 25% to 35% discount to the banking sector as a whole. Of course, we must consider whether or not this apparent discount is pricing for the bank’s elevated risk compared to others.
Importantly, Truist is one of the most impacted banks by the increase in long-term securities interest rates, giving the bank huge unrealized securities losses. Based on its most recent balance sheet (pg. 12), we can see that Truist has about $56B in held-to-maturity “HTM” agency mortgage-backed-securities “MBS” at amortized cost, worth ~$46B at fair value, giving Truist a $10B loss that is not accounted for in its book value. That figure has remained virtually unchanged since its Q4 2022 earnings report through Q2 2023; however, it will rise with mortgage rates since higher rates lower the fair value of MBS assets. Truist’s Q2 report also notes that all of its HTM MBS securities are at due over ten years, meaning they’re likely ~20-30 year mortgage assets that carry the most significant duration risk (or negative valuation impact from higher mortgage rates).
Significantly, the long-term Treasury and mortgage rates have risen in recent weeks as the yield curve begins to steepen without the short-term rate outlook declining. See below:
Data by YCharts
From the late 2021 lows through the end of June, the long-term mortgage rate rose by around 4%, lowering Truist’s MBS HTM assets fair value by ~$10B, while its available-for-sale securities lost ~$11.9B in value (predominantly due to MBS assets as well). Accordingly, we can estimate that the duration of its securities portfolio (almost entirely agency MBS) is roughly $5.5B in estimated losses per 1% increase in mortgage rates. Since the end of June, mortgage rates have risen by approximately 35 bps, giving TFC an estimated Q3 securities loss of ~$1.9B. Around $1B should show up on TFC’s balance sheet and income, while ~$900M will remain unrealized based on its current AFS vs. HTM portioning.
For me, we must value TFC accounting for both. Total unrealized losses and estimated losses based on the most recent changes in long-term interest rates. That said, should mortgage rates reverse lower, Truist should not have that $1.9B estimated securities loss in Q3; however, should mortgage rates continue to rise, the bank should post an even more considerable securities loss. At the end of Q2, Truist had a tangible book value of $22.9B. After accounting for unrealized losses, that figure would be around $12.9B. After considering the losses associated with the recent mortgage rate spike, its “liquidation value” is likely closer to $11B. Of course, Truist has a massive ~$34B total intangibles position due to goodwill created in its acquisition spree over the past decade. Although relevant, I believe investors should be careful in accounting for goodwill due to the general decline of the financial sector in recent years.
While much focus has been placed on unrealized securities losses, the risk associated with those losses is vague. Truist can borrow money from the Federal Reserve at par against those assets, partially lowering the associated liquidity risk. However, the Fed’s financing program is at a much higher discount rate (compared to deposit rates) and only lasts one year, so it is not a permanent solution. Further, the unrealized securities losses are on held-to-maturity assets, meaning it will recoup the losses should the assets be held to maturity. Of course, that means it may take 20-30 years, and Truist may need that money before then.
Further, Truist has a substantial residential mortgage portfolio at a $56B cost value at the end of Q2 (data on pg. 48). Those loans had an annualized yield of 3.58% in 2022 and 3.77% in 2023; since the yield did not rise proportionally to mortgage rates, we know the vast majority of those loans are likely fixed-rate long-term. Since they’re not securities positions, Truist need not publish their changes in fair value; however, should Truist look to sell its residential mortgages, they would almost certainly sell at a similar total discount to its MBS assets, considering its yield level is akin to that of long-term fixed-rate mortgages before 2022. I believe the unrealized loss on those loans is likely around $10B.
The rest of Truist’s loan portfolio, worth $326B at cost, is predominantly commercial and industrial ($166B), “other” consumer ($28B), indirect auto ($26.5B), and CRE loans ($22.7B). Excluding residential mortgages, all of its loan portfolio segments have yields ranging from 6-8% (excluding credit cards at 11.5%), with those segments’ total yields rising by around 3-4% from June 2022 to 2023. Accordingly, it is virtually certain that most of its non-mortgage loans are either short-term or fixed-rate since their yields rose with Treasuries, meaning they do not likely face unrealized losses based on the increase in rates.
Overall, I believe that if Truist were to liquidate its assets, its net equity value for common stockholders would be roughly zero, technically $1B. That figure is based on its current tangible book value, subtracting known unrealized losses on securities (~$10B), estimated recent Q3 realized and unrealized losses (~$1.9B), and estimated unrealized mortgage residential loan losses (~$10B). While the bank does have some MSR assets, worth ~$3B, that are positively correlated to rates, I do not believe that segment will offset unrealized losses in any significant manner. Together, those figures equal its tangible book value and would lower the total book value to about $34B. However, in my view, intangibles are not appropriate to account for today because virtually all banks have lost value since its 2019 merger, making its goodwill an essentially meaningless figure.
From a NAV standpoint, TFC is not trading at a discount and is most likely trading at a significant premium. Further, based on these data, Truist is, in my view, seriously undercapitalized. Although TFC posts a CET1 ratio of 9.6%, which is also relatively low, its common tangible equity would be essentially zero if its loans and securities were all accounted for at fair value. To me, that is important because most of its losses are on ultra-long-term assets so it may need that lost solvency sometime before those assets’ maturity. Further, even its 9.6% CET1 ratio is close to its new regulatory minimum of 7.4%, so a slight increase in loan losses or a realization of its estimated ~$22B in unrealized losses would quickly push it below the regulatory minimum.
Truist Earnings Outlook Poor As Costs Rise
To me, Truist is not a value opportunity because it is not discounted to its tangible NAV value. Even its market capitalization is around 65% above its tangible book value, which does not account for its substantial unrealized losses. However, many investors are likely not particularly concerned with its solvency, as that could not be a significant issue if there are no increases in loan losses, declines in deposits, or sharp NIM compression. If Truist can maintain solid operating cash flows, that could compensate for its poor solvency profile.
Of course, TFC cannot continue to try to expand its EPS by increasing its leverage since it is objectively overleveraged, nearly failing its recent stress test. On that note, poor stress test results are essential, but “passing” is somewhat inconsequential, considering most of the recently failed banks would have passed with flying colors, as the test does not account for the substantial negative impacts of unrealized losses on fixed-income assets. That is likely because, when “stress testing” was designed, it was uncommon for long-term rates to spike with inflation as it had, and banks had much lower securities positions compared to loans. Thus, it is quite notable that TFC nearly failed a test that does not account for its substantial unrealized losses.
Looking forward, I believe it is very likely that Truist will face a notable decline in its net interest income over the coming year or more. Fundamentally, this is due to the decrease in Truist’s deposits, total bank deposits, and the money supply. As the Federal Reserve allows its assets to mature, money is effectively removed from the economy; thus, total commercial bank deposits are trending lower. Truist’s deposits are trending lower in line with total commercial banks. I expect Truist’s deposits to continue to slide as long as the Federal Reserve does not return to QE. As Truist competes for a smaller pool of deposits, its deposit costs should rise faster than its loan yields. Today, we’re starting to see the spread between prime loans and the 3-month CD contract, indicating that bank NIMs are declining. See below:
Data by YCharts
Truist’s core net interest margin has slid from 3.17% in Q4 2022 to 3.1% in Q1 2023 to 2.85% in Q2. Truist’s deposits (10-Q pg. 48) have generally fallen faster than its larger peers, so it needs to increase deposit costs more quickly. Over the past year, its total interest-bearing deposit rate rose from 14 bps to 2.19%, with the most significant rise in CDs to 3.73%.
Notably, Truist has increased its CD rate to the 4.5% to 5% range to try to attract depositors. However, the bank continues not to pay any yield on the bulk of its savings account products, causing a sharp increase in customers switching toward the many banks which pay closer to 5% today. Over the past year, the bank saw around $10B in outflows for interest-bearing deposits and about $25B from non-interest-bearing deposits, making up for those losses with new long-term debt and CDs. Problematically, that means Truist is rapidly losing more-secure liabilities to more fickle ones like CDs and the money market. While this effort may slow the inevitable decline of its NIMs, it will also increase Truist’s solvency risk because it’s becoming more dependent on less secure liquidity sources as people move money between CDs more frequently than opening and closing savings accounts at different banks.
Truist also faces increased expected loan losses due to a rise in late payments last quarter. That trend is correlated to the increase in consumer defaults and the sharp decline in manufacturing economic strength. See below:
Data by YCharts
Consumer defaults remain normal, but I believe they will rise as consumer savings levels continue to fall and should accelerate lower with student loan repayments. The low PMI figure shows many companies face negative business activity trends, increasing future loan loss risks on Truist’s vast commercial and industrial loan book. Of course, Truist also has a notable CRE loan portfolio, which faces critical risks associated with that sector’s colossal decline this year.
The Bottom Line
Overall, I believe Truist has become even more undercapitalized since I covered it last. I also think Truist faces an increased risk of recession-related loan losses and has a more sharp NIM outlook. Even more significant increases in mortgage rates recently exacerbated strains on its capitalization, while its low savings rates should cause continued deposit outflows. Further, its increased CD rates should create growing negative net interest income pressure.
If there was no recessionary potential, as indicated by the manufacturing PMI, then TFC may manage to get through this period without severe strains; however, its EPS should still decline significantly due to rising deposit costs. That said, if Truist’s loan losses continue to grow due to increasing consumer and business headwinds, its low tangible capitalization leaves it at high risk of significant downsides. If its loan losses grow or its deposits decline, it will need to realize more losses on its assets, quickly pushing its CET1 ratio below its new regulatory minimum. Personally, I strongly expect TFC’s CET1 ratio will fall below the 7.5% level over the next year and could fall even lower if a more severe recession occurs.
I am very bearish on TFC and do not believe there is any realistic discount potential in the stock besides that generated by speculators. Since there is a significant retail speculative activity in TFC and some potential for positive government intervention due to its larger size, I would not short TFC. Although TFC downside risk appears significant, many factors could create sufficient temporary upside that it is not worth short–selling. That said, I believe Truist may be the most important financial risk in the US banking system due to its solvency concerns combined with its size and scope. Accordingly, regardless of their position in TFC, investors may want to keep a particularly close eye on the company because it may create more extensive financial market turbulence than seen from First Republic Bank should it continue to face strains.
Eight times every year, the Federal Reserve’s Federal Open Market Committee (FOMC) meets to discuss and possibly alter their position on monetary policy.
There are several different courses of action they could take, the most common being quantitative easing, buying and selling government securities, and raising or lowering the federal funds rate.
Most recently, the fed’s tool of choice has been adjusting the federal funds rate.
What is the federal funds rate?
The federal funds rate is the rate at which depository institutions (banks and credit unions) charge each other for overnight deposits.
Why would they need to lend each other money? All banks are required to have a certain amount of funds in their reserves (usually 10%), and sometimes customers withdraw enough money from the bank that the bank’s reserves are below the requirement. They now have two options: to borrow money from the fed or from another bank. The federal funds rate determines how much interest a bank will have to pay for that loan.
Click here for today’s mortgage rates.
How the federal funds rate affects the economy
The federal funds rate is an important base rate that has trickle down effects on the entire economy. After all, if the federal funds rate goes up and banks have to pay more for overnight loans, then it goes to reason that they are going to have to make up the higher cost by raising their own rates. Conversely, if the federal funds rate is lowered, banks can pass lower interest rates on to their borrowers.
With the benchmark federal funds rate lowered, rates on credit cards and business loans also decline, encouraging lending for both businesses and consumers. Businesses are able invest in infrastructure and hire more employees, while consumers make more payments on credit knowing that they don’t get charged as much on the interest.
This results in more financial transactions, ultimately contributing to economic growth of the nation at large. That’s why when the Fed wants to promote economic growth they lower the federal funds rate, and when they think the economy can handle it, they raise the federal funds rate.
Mortgage rates and the Federal Reserve
Understanding mortgage rates can be tricky. The way the situation with the Fed raising and lowering rates is portrayed in the news leads many people to believe that the Fed controls mortgage rates. This is not true—the Fed does not directly set mortgage rates at all. However, that’s not to say that it has no influence over mortgage rates.
Fedspeak
At the Federal Reserve, the forward guidance “fedspeak” that officials offer up to the markets is one of the most powerful tools they have. It’s actually a little bit of the opposite of that old saying that “Actions speak louder than words.”
Generally, when a fed official comes out and gives even the slightest hint that they are in favor of rising rates, investors move away from “safe” government bonds and into riskier assets like stocks. That’s good for the economy, but it causes mortgage rates to rise.
As we’ve seen several times this year, the fed can create a buzz about raising the fed funds rate (which can drive up mortgage rates), but then retreat back from that position and not raise rates (causing rates to fall back down).
It’s this cat and mouse game of talking and not delivering that has landed the Fed in hot water, with some critics claiming the Fed has a credibility problem. Regardless of whether or not you agree with them, it’s undeniable that what the Fed says can influence markets.
Click here for today’s mortgage rates.
How mortgage rates are actually set
If the Federal Reserve doesn’t set mortgage rates, who does?
Good question.
Just as is the case with many other aspects of the economy, market forces are to thank (or blame). Most of the action takes place on the secondary market, where mortgage-backed-securities (MBS) are bought and sold.
These mortgage bonds have prices and yields that move up and down just like stocks and bonds do. If the economy is performing well, investors expect higher yields, and vice versa when the economy is under-performing. So in a way, mortgage rates are a reflection of how well the economy is doing. Specifically, the three major drivers of mortgage rates are:
Stock prices
The labor market
Inflation
As stated, when stock prices are going up, so are mortgage rates. That’s because mortgage-backed-securities are traded as bonds, and conventional wisdom says that when investors are moving money into stocks, they’re taking money out of bonds.
With a decrease in demand for bonds, prices drop and yields rise–pushing rates higher. In the event that investors flood back into bonds, the opposite will happen, causing mortgage rates to drop.
It’s not a perfect relationship, but it’s generally how the market behaves. The relationship between bonds and mortgage rates is best illustrated by the yield on the U.S. 10-year treasury note, which is the best market indicator of where mortgage rates are going.
On any given day, looking at the 10-year yield will give you a fairly accurate picture of where mortgage rates are headed. If the yield is rising, mortgage rates most likely are too, and vice versa.
With the labor market, it’s all about how high unemployment is. The Bureau of Labor Statistics (BLS) releases a monthly employment situation report that is the most-watched report on the matter. If the U.S. economy added fewer jobs than expected and the unemployment rate rises, that’s bad news for the stock market, which as we now know pushes mortgage rates lower.
Most people understand inflation as a rise in the cost of living. That’s true, but what’s really happening is the devaluing of the dollar. As the value of the dollar declines, the purchasing power of the dollar diminishes, causing prices to rise.
Mortgage-backed-securities, like every other bond, are denominated in U.S. dollars. Since investors don’t want to own assets that are losing their value over time, they move away from MBS in times of high inflation. With a decrease in demand for MBS, the yields rise, driving mortgage rates higher.
Bottom line
When you’re trying to understand mortgage rates, remember: the Federal Reserve and the federal funds rate do not control mortgage rates. There are several other economic factors at play that anyone trying to track and predict where mortgage rates are going should pay attention to.
That being said, the Federal Reserve does play a major role by influencing how the economy functions, and it’s always important to keep an ear out for what they’re saying.
1. chart via wikipedia
Carter Wessman
Carter Wessman is originally from the charming town of Norfolk, Massachusetts. When he isn’t busy writing about mortgage related topics, you can find him playing table tennis, or jamming on his bass guitar.
Despite mortgage rates rising slightly from a previous all-time low, mortgage applications gained 6.8% last week, according to a report from the Mortgage Bankers Association.
The refinance index continued its upward climb, gaining 9% last week and jumping 86% higher than the same week one year ago. Refinances also reached a nearly two thirds share of mortgage activity last week, increasing to 64.3% of total applications from 62.8% the week prior.
According to Mike Fratantoni, chief economist and vice president of research and technology at MBA, 2003 was the last time refinance activity was as high as the $1.75 trillion the MBA is forecasting for 2020.
On Sept. 9, Joel Kan, MBA’s associate vice president of economic and industry forecasting, said the recent rebound in refinance activity was driven mainly by borrowers applying for conventional loans. However, last week Kan noted that while conventional and government refinances gained steam, FHA refis experienced a particular uptick.
On an unadjusted basis, purchase applications rose 13% compared with the previous week and were 25% higher than the same week one year ago – marking the 18th straight week of year-over-year gains.
The demand for higher-balance loans pushed the average purchase loan size to another record high, signaling that consumers’ strong interest in home-buying this summer has now carried over to the fall, Kan said.
The adjustable-rate mortgage (ARM) share of activity fell slightly to 2.2% from 2.3% of total applications.
Here is a more detailed breakdown of this week’s mortgage application data:
The FHA’s share of mortgage apps rose to 10.1% from 9.7%.
The VA share of applications fell to 12% from 12.3%.
The USDA share of total applications rose to 0.6% from 0.5%.
The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($510,400 or less) rose to 3.1% from 3.07%.
The average contract interest rate for 30-year fixed-rate mortgages with jumbo loan balances (greater than $510,400) fell to 3.35% from 3.41%.
The average contract interest rate for 30-year fixed-rate mortgages backed by the FHA rose to 3.23% from 3.16%.
The average contract interest rate for 15-year fixed-rate mortgages rose to 2.64% from 2.61%.
The average contract interest rate for 5/1 ARMs fell to 3.19% from 3.2%.
With the mortgage industry still rightsizing, mortgage professionals are worried about regulation of the industry and inflation that thins already tiny margins. Industry players are largely pessimistic about the economic climate and expect interest rates to trend up in the near term future, according to the HousingWire Q2 2023 LenderPulse survey.
Roughly 30% of 155 respondents of the LenderPulse survey pointed to increased regulation, rising interest rates and inflation as the biggest challenge they face in the next three months, out of a total of 11 options that included lender stability, underwriting problems and competitiveness of product offerings.
About 19.4% of the surveyed mortgage professionals said loans falling through was the biggest challenge, ranking as the second most challenging factor. Lead generation ranked as the third biggest hurdle at 15.5% and staying motivated trailed at the fourth place at 14.2%.
Other challenges selected by mortgage professionals were relationships with real estate agents at 8.4%; competitiveness of rate sheet and underwriting problems at 5.8%; lender stability at 3.9%; competitiveness of product offerings at 1.9%. None of the surveyed mortgage professionals said staff cuts caused decreased ability to close loans and lack of training were the challenges they faced.
LenderPulse requests surveys from 24,000 mortgage professionals across the country on market trends and lender opportunities and challenges. Of the 155 completed surveys, 32.3% of the respondents were from the Southwest, 21.3% from the Midwest, 16.8% from the Northeast, and 14.8% of the respondents from the Northwest and Southeast. RealTrends LenderPulse is a forward-looking quarterly survey. The survey was conducted from February 27 to April 3.
Economic and Housing Market Outlook
Amid theFederal Reserve‘s efforts to tame inflation, 44.5% of surveyed mortgage professionals expressed pessimism about the economy in the next three months. Of the total, 36.1% were neutral and 19.4% were optimistic.
Mortgage professionals’ pessimism about the economy in the near term stemmed from expectations of interest rates trending higher.
About 47.1% of the respondents said rates will likely go up in the next three months, 30.1% of the survey participants said rates will remain flat while 22% said rates will trend down.
A total of 45% of participants said home sales in their markets will remain flat for the next three months; 30.3% said sales will go up more than 5%; and 25.2% expected sales to go down more than 5%
In the latest report from the National Association of Realtors (NAR), existing home sales rose 14.5% in February month over month for the first time after 12 months of decline.
Incentives in the Market
In a higher-rate environment, temporary rate buydowns funded by sellers, lenders or builders were widely offered as an incentive for buyers.
The majority of the 155 respondents – about 70% of the total – noted temporary rate buydowns funded by the seller, builder or lender are offered as incentives to buyers.
“Sellers are entertaining offers with rate buydowns and concessions to keep this market going but also to sell their property,” a loan originator in California said.
In a high-rate environment, lenders call the temporary rate buydown a win-win strategy for both sellers and buyers when used appropriately.
For example, a 2-1 buydown can be paid for by the homebuyer or the home seller can pay for it as a seller concession. That payment can be made in the form of mortgage points or a lump sum deposited in an escrow account with the lender and used to subsidize the borrower’s reduced monthly payments.
“As it pertains to buydowns and or seller funded buydowns, in my opinion and from my perspective I feel this product is really only viable and something that makes sense for a borrower if the buydown is seller or builder funded,” an operations manager based in California said. “It is essentially free money that would be credited back to the borrower should they pay the loan off within the buy down structure (1/0, 2/1, or 3/2/1).”
Seller credit for closing costs, price reductions waiving of fees, and adjustable-rate mortgages (ARMs) were also mentioned by mortgage professionals as incentives offered in the market.
“The 2/1 buydowns were working great, but now the market has tightened with a lack of supply of homes on the market, so a lot of the sellers quit offering this or accepting this,” a mortgage broker in Arizona said.
“Borrowers opt for ARMs more often than a fixed rate for a more competitive rate. Many are curious about buydowns but we are currently operating in what is still a seller’s market so not seeing many seller-funded buydowns,” a loan officer in Boston noted.
Pivot to a purchase mortgage market
In a purchase mortgage-focused market, getting referrals from real estate agents is key to landing business.
Keeping in contact with Realtors periodically, forming new relationships at open houses and setting up in-person meetings were how mortgage professionals strengthened relationships with realtors, according to the submitted written responses.
“Volunteering with our local Board of Realtors, on three (3) committees; Education, Banking & Finance and Membership Engagement. Looking to form relationships that I can turn into referrals down the road once they realize how organized I am, how smart I am and that I am a relationship lender in a local community bank!” a loan officer in Washington noted.
Sharing leads and sending out newsletters are ways loan officers try to get themselves to stand out in a highly competitive industry.
“Actively engaging with them, monthly lending newsletter, training opportunities [is how we strengthen relationships with Realtors],” an executive at a regional bank in Michigan said in a written response.
“Our goal is to strengthen our Realtor partners relative to their competitors. To do this, we’re holding skills and knowledge classes and meeting face to face to share best practices,” a loan officer located in Texas said.
If you have questions about LendingPulse email RealTrends Editorial Director Tracey Velt at [email protected]. Also, be sure to sign up for the new Data Digest newsletter, a weekly breakdown of news, tips and strategies for success.