The other housing shoe drops on mortgage margins

By now, everyone knows that housing inventory in Idaho is anemic going on anorexic. What may be a surprise is that mortgage lenders are increasingly pessimistic over margins, which are shrinking and will continue to shrink. This is because the refinancing boom of last year is over and mortgages-to-purchase in the current home market are squeezing profits margins tighter than a hippo in spandex.

The Fannie Mae Q2 mortgage lender sentiment survey found that an increased share of mortgage lenders believe profit margins will retreat further from last year’s highs in the upcoming third quarter.

“Despite elevated optimism toward the U.S. economy, lenders show a cautious outlook for their mortgage business,” said Doug Duncan, Fannie Mae senior vice president and chief economist, in a statement. “This quarter, the largest net percentage of lenders in the survey’s seven-year history are expecting a decrease in their profit margin outlook. This is the third quarterly decline from the lender profitability highs of 2020.”

In this market, even staid mortgage bankers can set new housing-related records. Last year’s boom year in mortgages was fueled by a surge of customers refinancing their older home loans, taking advantage of the record-low interest rates, which were the lowest in over a half century.

Duncan added: “Lenders reported a significant refinance demand decline over the past three months and expect the decline to continue, with their refinance demand growth expectations reaching the lowest level seen since Q4 2018. With the shift from refinance to purchase business, some lenders commented that purchase transactions are harder to complete and have lower margin.”

Which way will mortgage interest go?

In general, mortgage interest tracks 10-year Treasuries, but not always. The pandemic economic downturn was a good example of mortgage rates decoupling from 10-year Treasuries as investors fled to the safe haven of low-risk U.S. government bonds, which drives rates downward. It took a year for mortgages to start tracking 10-year Treasuries again, signaling that the economy may truly be on the path to recovery. The Idaho Business Review asked Zions Bank for its perspective on the behavior of the spread over the last year and what significance it may have on the current mortgage market.

Robert Spendlove, economic and public policy officer at Zions, had this to say: “While 30-year mortgage rates are closely associated with the 10-year Treasury, they aren’t perfectly correlated. While the spread is typically pretty constant, the pandemic recession has caused the two rates to disconnect somewhat over the last year. Mortgage rates are driven by demand for mortgage-backed securities, which have been driven by high demand for mortgages and refinancing. On the other hand, the 10-year Treasury is determined by demand for bonds issued by the Federal Government. While the current spread is larger than typical, I expect it to narrow as markets continue return to normal.”

The 10-year Treasury may go down if the COVID-19 surges in southeast Asia and South America send foreign investors to move money into the safety of U.S. Treasury instruments. Large-scale movements into low-risk Treasuries sends their rates downward. If mortgage interest continues its recently-reestablished tracking of 10-year Treasuries while Treasury rate stays low, mortgages will follow. Because low mortgage rates are one of the metrics driving home-purchase demand, continuing low rates will not help the run-up of home prices to cool off.

Mortgage rates going up?

Even the Federal Reserve notes that the progress of the COVID-19 pandemic will have a major effect on inflation and interest rates. On June 16, the Fed signaled that it expects to raise interest rates in 2023, according to new economic projections, which is not what it said in its previous forecast in arch, when it predicted rates would stay near zero for at least the next two years. This is a signal that the rate on Treasury debt instruments will raise over this timeframe. If the recently reestablished spread continues, then rising mortgage rates will finally exert some downward pressure on home prices.

Jared Cook, regional mortgage manager for Zions Bank, remarked: “Any future increase in interest rates will also increase home payments, which will reduce demand for more expensive homes and help slow home price appreciation.”

There is more at play in Idaho that just mortgage interest, Cook explained: “Home price increases have been exacerbated by several factors. In-migration to Idaho increased during the COVID-19 pandemic and Boise is an attractive location for many professionals who can work remotely. At the same time, the costs of lumber have skyrocketed and construction companies have experienced challenges finding workers, adding more pressure to our limited housing supply. The good news for prospective homebuyers is that some of these pressures may be temporary. As our economy recovers from the COVID-19 induced supply shortage and more employees return to their offices, it should alleviate some of the pressure from the tight Idaho housing market.”