What is MBS speculative pricing and why it is hurting mortgage rates?

Minneapolis, MN:  MBS speculative pricing (mortgage backed securities) is one big reason that mortgage interest rates today are pretty good IF you are willing to pay a few discount point, but much higher if you are not.

Mortgage rates, just like just about everything else you buy has a markup and profit margin. Speculative pricing is part of what factors into what Fannie Mae and Freddie Mac pay to lenders to buy loans from them based on Fannie and Freddie’s prediction on how long they think a loan is going to be held on their books.  The longer a loan is held, the more interest paid, the more profit they make.

This is an overly simplistic example, but after a mortgage broker or lender does a home loan, they almost always sell it to Fannie Mae and Freddie Mac afterwards.

There is a calculation of what that loan is worth to them.  Let’s say the assumption that the typically loan stays on the books for 10-years.

Should you pay discount points? Why are points a big thing today?

Based on that assumption of time, Fannie and Freddie may then are willing to pay the original lender a premium of lets say 2% of the loan amount to acquire the loan. The original lender is now out of the picture, and Fannie and Freddie collect all the interest over time.

Historically, this has worked out very nicely for Fannie and Freddie, the original lender, and the homeowner.

Everything is messed up right now because as we all know, to fight inflation, the Federal Reserve has raised the Feds Fund Rate, which is the rate banks basically pay to borrow money.  If the banks have to pay more, they pass that cost along to you in the form of higher mortgage rates, car loans, credit cards, etc.

We all know that the inflation rate, while high, is slowly coming down.  As it comes down more, the Federal Reserve will be forced to lower the Fed Funds Rate or face the risk of causing other issues in the markets.

Just like when it went up, as it comes down, banks will lower that rates to consumers, resulting in lower mortgage rates, car loan rates, credit card rates, etc.

Fannie and Freddie know that anyone who bought a home, or did a mortgage loan recently will very likely be refinancing within the next year or two when mortgage interest rates fall.

The Current Problem

Because Fannie and Freddie know that the typical home loan is unlikely to stay on the books for (in our example, 10-years), and maybe really only 2-years, and that they will collect dramatically less interest over only 2-years versus 10-years, they are no longer willing to pay the lender that example 2% premium for buying your loan. They may currently be only willing to pay the lender 0.5%, or worse yet, nothing at all for your loan.

Lenders Don’t Work For Free

Lenders don’t work for free. Without the premium being paid for the loan from Fannie and Freddie, lenders have to get paid from somewhere, and that somewhere is from the homeowner in the form of discount points.

If the homeowner doesn’t want to pay points, or if they can’t afford to pay the points, lenders have no choice but to raise the interest rate you pay for the mortgage loan to make it more attractive to Fannie Mae and Freddie Mac to purchase, so lenders will again get paid when they sell the loan.

Confused?

Simply put, your loan isn’t worth much today because they know you are going to refinance it when rates drop and they didn’t make much money on interest.

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