Why might mortgage rates go up when interest rates are going down?

Posted by Jeff Ball on Mar 18, 2020 9:08:52 AM

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Mortgage rates can go up even when interest rates are going down if credit spreads increase more than interest rates decrease.

Let’s break that down.

Mortgage lenders borrow money to lend money.  Many mortgage lenders, including Visio, borrow money in the bond, or securitization, markets to permanently finance their mortgage loans.

Interest rates in the securitization market are made up of two primary components including the base, or index, rate and a credit spread.

The index rate typically is tied to the rates on U.S. Treasury bonds.  So as the rates related those bonds go down, the cost to finance in the securitization market goes down provided the credit spreads do not go up.

Credit spreads are driven by several factors.  Maybe most importantly, the credit spread represents the increased amount of return a bond investor requires for the risk they perceive they are taking by not simply investing in the government bond used for the index rate.

The coronavirus has introduced significant uncertainty into the world.  As a result, investors around the globe are “fleeing to safety.”  U.S. government bonds are viewed among the safest investments in the world.  Global investors are buying U.S. government bonds driving down interest rates.  If investors are fleeing to safety, they are fleeing away from other asset classes, including the stock market and many portions of the bond market, including mortgage securitizations.  This has caused credit spreads to increase more than interest rates have declined.

If credit spreads increase more than the interests decline, mortgage lenders’ financing costs in the securitization market increase and mortgage lenders have to raise their rates to remain viable.

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Related: A Look at the Impact of the Coronaviurs on the Housing Market, Prepare Your Vacation Rentals for the Coronavirus

Topics: Finance

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