Yield Curve Inversion in the Mortgage Market

Mortgage rates are at their lowest levels in three years. A mortgage refinance boom is underway. As yields on long-term U.S. Treasuries have come down, so have mortgage rates. The 30-year fixed rate reached almost 5.0% in November 2018. It fell to 3.90% last week. According to the Mortgage Banker’s Association, refinance rates are 180% higher than a year ago.

10-year chart of 30 and 15-year fixed rate mortgage rates

US mortgage rates at 3 year lows

When it comes to mortgages, I am a big fan of 5/7/10 year ARMs (adjustable rate mortgages). These loans are amortized over a 30-year period, so the payment is similar to a 30-year fixed rate loan. The main difference is that after the fixed term (5, 7, or 10 years), the interest rate floats to match current market rates. ARMs generally have lower rates than 30-year fixed loans, providing significant savings in the first few years of the loan. While 15-year fixed rate loans have even lower rates, they require a more aggressive amortization schedule, resulting in a higher monthly payment that many homebuyers cannot afford.

Few homeowners stay in the same house for 30 years. The average length of homeownership is 13 years. When I bought my house in 2014, I knew it wasn’t my forever home. I took a 7-year ARM with plans to move to a bigger house at the end of that time-frame. I recall the 30-year fixed rate was 0.50% – 0.60% higher than the rate on my loan at the time. I was willing to trade that savings for the risk my loan would adjust to a higher rate in 7 years. I expected my earnings to be higher by then anyway.

Something fascinating and strange is happening with adjustable rate loans. There is a yield curve inversion in the mortgage market this week. According to BankRate.com, the rates on 5/7/10 year ARMs are actually higher than the 30-year fixed rate. This makes absolutely no sense. Why would a homeowner pay more and take on interest rate risk in 5 or 10 years? Shockingly, a 5-year ARM carries an interest rate of 3.87% versus 3.69% for a 30-year fixed rate. 5/7 year ARMs for jumbo loans larger than $484,250 do not seem to be experiencing the same inversion, however.

Here is a screenshot of today’s average mortgage rates from Bankrate.com:

us mortgage rates

I realize these are loans ‘for purchase’, but I know a buyer who was quoted a higher rate on an ARM this week than on a 30-year fixed loan. 

The rate a homeowner can obtain today will be different than these averages. There are multiple factors affecting a buyer’s mortgage rate. Is this a purchase or a refinance? Refinance rates are higher. Multi-family properties and condos tend to have higher rates than single-family homes. Rental properties and vacations cost more than primary residences. Buyers with lower credit scores pay higher rates. Banks give preferential rates to customers with large balances in their savings or investment accounts.

If you are in the market to refinance, be sure to check with at least three institutions to get quotes. Keep in mind that a lower rate doesn’t always translate to savings. The interest in a mortgage loan is front-loaded, which means a higher percentage of your monthly payment goes to pay interest instead of principal during the early years of the loan. When you refinance, you are usually restarting that amortization schedule. Make sure to calculate all the costs involved before jumping for that lower rate.

 

 

 

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