Mortgage rates below 3%? Treasury rates are part of the puzzle

The average 30-year mortgage rate could drop below 3%, an incredibly low level that could lead even more Americans to refinance. But for mortgage rates to break through this historic barrier, financial forces would have to line up in a way some economists consider unlikely.

Perhaps the most important, Treasury rate should stay at the lowest. The 10-year Treasury rate fell from 1.52% on February 20 to just 0.54% on March 9, in response to the coronavirus pandemic. The rate has hovered around 0.6 percent since then.

The 10-year Treasury acts as a reliable indicator of economic sentiment and as a key benchmark for mortgage rates. In 2019, the spread between the 10-year Treasury and the 30-year mortgage averaged 1.79 points, according to Bankrate analysis of data compiled by the Federal Reserve Bank of St. Louis. If the spread between Treasury rates and mortgage rates had remained at last year’s level, mortgage rates would have already plunged below 2.5%.

A new abnormal

This is not what happened, of course. As the coronavirus rocked the U.S. economy, the gap widened to 2.72 points. “The spread between 30-year mortgage rates and 10-year Treasury rates has been unusually high,” says Michael Fratantoni, chief economist of the Mortgage Bankers Association (MBA).

Why such a big gap? Partly because lenders simply cannot handle more business than they already have. A drop in mortgage rates at the start of the year led to a wave of refinancing. Even with rates at 3.5 percent, lenders are overwhelmed. So just like a retailer wouldn’t lower the price of a hot-selling item, lenders didn’t need to lower mortgage rates further.

Soaring unemployment rates play a role

The gap has also widened because that is exactly what happens when the economy crashes. The national unemployment rate fell from an all-time low of 3.5% in February to an all-time high of 14.7% in May, leaving millions of borrowers unable to make their monthly payments.

During the 2008 financial crisis, the spread between Treasury rates and mortgage rates reached almost 3 percentage points. The gap is almost as dramatic now. “This larger gap, I believe, is primarily due to the increased risk lenders perceive in the face of rising unemployment,” says Lynn Reaser, economist at Point Loma Nazarene University in San Diego and former chief economist at Bank of America.

So what happens next? If Treasury rates stay low and lenders clear their backlog of refinancing requests, mortgage rates could indeed drop below 3%, says Fratantoni. But that’s not what he expects. The MBA predicts that rates will stay in the 3.4% range.

Massive stimulus measures hit markets

To explain, Fratantoni points to 3 trillion dollars of stimuli injected into the American economy since March. For now, there is a demand for US debt at microscopic rates, but it might not last. “If it was only the United States doing this, there would be a lot of Treasury debt buyers,” Fratantoni said.

However, Europe and Asia are also launching their own stimulus packages and also selling debt. “We are going to be competing with more and more sovereign borrowers for the same group of investors,” said Fratantoni.

Reaser also expects mortgage rates to stay between 3.25% and 3.5%, and she sees another reason Treasury rates could rebound: America has reopened. “If the economy starts to improve significantly,” she said, “Treasury rates could drop to 0.85% or up to 1%.

Some experts say rates will go down

Mortgage rate predictions are far from unanimous. Mortgage giant Fannie Mae and the National Association of Realtors expect rates to drop below 3% later this year.

Even if rates remain in the 3.5% range, millions of US homeowners could benefit from refinancing. This raises a question: Should you refinance now, or should you wait and hope rates fall even more? Normally, mortgage experts advise refinancing as soon as it makes sense. These are not normal times, however, and no forecaster expects rates to rise significantly in the near future.

What you can do to ensure a smooth refinancing

Keep in mind that refinancing is not free. You will be paying around 2% of the loan amount in fees, so you need to save enough through lower monthly payments to make up for this upfront cost. Whenever you decide to refinance, here are a few ways to make the refi process as profitable as possible:

  • Compare the prices: Some lenders are already offering rates below 3. For example, Third Federal Savings of Cleveland markets 30-year loans at 2.99%. United Wholesale Mortgages touted rates as low as 2.5 percent.
  • Put your papers in order: Don’t let something simple like a missing document delay your refinance. Collect PDF files of financial documents including pay stubs, bank statements, tax returns, and retirement accounts.
  • Ask about lock rate: Lenders typically extend the rate freeze for 30 to 60 days, which means you won’t have to pay more if rates go up before your loan closes. These are not normal times, however, and many refinances don’t close within 30 to 60 days, so make sure your lender is prepared to extend your rate freeze if your deal is delayed.
  • Keep your credit rating greenhouse: Now is not the time to miss a payment, take on new debt, or do anything to lower your credit score. Lenders are particularly strict on the credit history of borrowers.

Image presented by John Keating / Newsday RM via Getty Images.

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