The recent uptick in US mortgage rates has home buyers scrambling to finalise new purchases. Since the election, a benchmark index of 30-year mortgage rates has gained half a per cent at a speed reminiscent of the taper tantrum in 2013. The impact on borrowers is clear. Several factors will determine the effect on lenders.
Predictably, the move has brought a decline in refinancing activity; no rational borrower will pre-pay when market rates are higher than the interest on their existing loans. Once the rush to beat the rise is over, higher rates may ultimately also mean less demand for mortgages in general as interest payments become less affordable. Wells Fargo made 10 per cent of this year’s non-interest income on mortgage originations. And nonbank lenders, often focused on refinancing existing mortgages, may have to rethink business models.
In the meantime, the average maturity of the bonds into which the mortgages are packaged will increase as prepayments become less likely. Mortgage-backed securities might then pay low coupons for longer. This increases duration, making their prices more vulnerable to the rising rates that extended their maturity.
For banks, higher rates will mean higher net interest income, although this benefit will take time to percolate through. More immediately, it will mean losses on mortgage-backed securities, although banks had already reduced their portfolio allocations to MBS as capital charges against them increased and lawsuits highlighted the reputational risk of lending to consumers. MBS losses may be offset by gains in the value of mortgage servicing rights, as lower refinancing activity means they will collect administration fees for longer. And gains on hedges will depend on the extent to which lower for longer expectations were built into them.
The Mortgage Bankers Association predicts an average rate of 4.8 per cent for 2018. How that would impact on demand among borrowers who have grown used to 30-year rates of 3.5 per cent is unclear. But habits form quickly, and mortgage related headwinds could loom both in the short and the longer term.
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