Even though mortgage rates are near all-time lows, many are looking at the benchmark 10-year Treasury yield and asking why mortgage rates are not even lower. Even though the 10 year Treasury yield (dark blue line) has fallen off a cliff, the average 30 year mortgage rate (light blue line) has remained stubbornly high. The difference between the two rates can be visualized in the lower panel. What gives?
There are several reasons for the difference in rates, which are illustrated in the chart below:
- Mortgage-backed securities (MBS) are not Treasury bonds. Yes, many MBS are backed by the federal government or by federally-backed Government-Sponsored Enterprises (GSEs, like Fannie Mae and Freddie Mac), but MBS are structured differently. One important distinction is that MBS can be “called” by the borrower and repaid early at par, which is typically done by refinancing the existing mortgage with a new mortgage at a lower rate. Thus, MBS yields (green line) are typically higher than Treasury yields (pink line) and they have not kept pace with the decline in Treasury yields in 2020 (MBS yields down about 1% YTD vs a roughly 1.5% decline in the 10 year Treasury yield YTD).
- The GSEs charge fees for securitizing and providing a federal backstop to MBS investors (these costs are why the white line is at a premium to the green line).
- Lenders need to generate a profit, so they add a spread on top of the rate that they commit to the GSEs. As of March 2020, lenders are reportedly at capacity for new loans, so there is no incentive for lenders to lower the rates offered to borrowers (even if the wholesale rates have declined). The red line represents the average 30-year mortgage rate.
The above only applies to government- and GSE-backed loans, known as “conforming” or “agency” mortgages. Non-agency mortgage rates are driven much more by investor risk appetite than the above factors.