Are mortgage rates too high? Blame the Federal Reserve, Wall Street, and your neighbors.

Mila Adams moved to Utah with her husband and toddler son in May.

The search for a home of their own has become a race for couples to stay ahead of the rapid rise in mortgage rates. The size of the house that can be bought has shrunk.

“We’ve seen some newer buildings and some older homes, but it seems like every time interest rates go up, the purchasing power goes down, and we have to readjust our budgets,” said the three-bedroom house. said Adams, 29, who was looking for a home. Enough for families planning to grow. “High home prices aren’t falling as quickly as interest rates are rising to adjust for that loss of purchasing power. Prices are kind of stubborn.”

The couple’s mortgage pre-approval was revoked when interest rates exceeded 7%. This was due to higher debt levels combined with my husband’s student loans from dental school making the debt levels too high.

“We’re very conservative with our finances and just want to have some headroom so that our family doesn’t become destitute,” Adams said.

It’s surprising that rapid interest rate hikes by the Federal Reserve aimed at curbing inflation and cooling an overheated housing market have pushed up mortgage rates, making it harder for many to buy a home. not. Changes in consumer behavior and investor decision-making on Wall Street are also responsible for rising interest rates.

Average 30-year fixed mortgage rates recently crossed the 7% threshold and retreated slightly on Thursday, analysts say, but investors, homeowners and prospective buyers are changing their behavior. If not, it can drop by up to 1%. It reacted very sharply to the Federal Reserve’s move.

“Mortgage rates are up one percentage point because of what’s going on in the mortgage market,” said Breen Capital mortgage analyst Scott Bukta. .”

Lenders take into account three different interest rates when determining the interest rates on mortgages offered to homebuyers.

The base rate is usually tied to the yield (or rate of return) on 10-year government bonds. This is used by most people to move to another house, prepay, or refinance within her 10 years of getting a mortgage. The second rate is associated with the yield differential between those bonds and mortgage-backed securities (MBS). In Wall Street parlance, this difference is known as the “spread.”

Finally, additional interest is charged that reflects the profits earned by lenders, servicers, and other players in the mortgage chain.

This is what happens behind the scenes.

Many banks and other lenders don’t hold onto the mortgages they set up. Instead, they package it into bonds that they sell to investors. Payments made by homeowners, such as interest payments and advance payments, flow to those investors. And the proceeds from selling bonds, which are an important source of funding for mortgage lenders, allow lenders to take out more mortgages.

In normal times, spreads between government bonds and mortgage-backed securities are fairly stable. But it changes quickly when interest rates rise, especially as it does now.

MBS investors, such as insurers, expect interest rates to continue to rise, causing people to stay home longer, slowing down mortgage advances and refinancings. This changes the calculation of the return an investor expects on a holding over a given time frame. Some investors sell bonds rather than stick around in search of higher returns elsewhere. Some demand higher interest rates from lenders to compensate for the additional risk of holding mortgage bonds.

Therefore, spreads, or the amount that fixed income investors are now expected to pay relative to government bonds, widen. The spread has more than doubled from 0.7% to 1.7% so far this year. The wider the spread, the more consumers pay because lenders pass the cost of their increased interest rates on to them.

The withdrawal of two of the largest holders of mortgage-backed securities from the market has not helped lenders.

Banks, both lenders and holders of mortgage bonds, are selling these holdings. U.S. commercial banks have sold about $200 billion in government-backed mortgage-backed securities since the central bank raised its first rate in March, according to Federal Reserve data. That’s a sharp reversal after he bought about $100 billion by March last September.

The Fed, another large mortgage buyer, is also absent. When the pandemic hit in March 2020, central banks rushed to prop up financial markets, buying government bonds and mortgage-backed securities to lower interest rates and support prices to revive the financial system. But since June, the Fed has allowed mortgage bonds to roll off their balance sheets as they mature.

“Market support is receding,” said Jason Curran, head of structured products at asset manager Columbia Threadneedle. It’s a U.S. bank, too. They haven’t been mortgage buyers all year.”

With demand for MBS so low, lenders who package and sell bonds are offering higher interest rates to lure investors back. These higher fees are also passed on to consumers.

Volatility in the mortgage market is hitting real estate investment trusts (REITs). A REIT is a publicly traded company that originates mortgages and purchases the bonds that serve as collateral. Although REITs are relatively small, they represent a significant portion of the market. Because his MBS purchase of a REIT will help Americans finance housing.

Annalee Capital Management, the largest mortgage REIT, recently announced that its book value (value of assets minus liabilities) has fallen by about 15% as a result of selling in the mortgage market. For AGNC, another large mortgage REIT, that figure was 20%.

REITs borrow money to buy mortgage bonds, originate mortgages, and collect interest on what consumers pay for their mortgages. In other words, you profit from the difference between the two. This makes them very sensitive to changes in interest rates.

To protect against interest rate fluctuations, REITs buy and sell US Treasuries and other securities designed to minimize interest rate risk. For example, when interest rates fall, consumers may buy longer-dated Treasuries to make up for some of the interest payments they lose by paying off their mortgages early.

Mortgage REITs have sold some of these hedges this year as interest rates have risen, adding to the broader sale of Treasuries that also impacts consumer mortgage rates.

“It wasn’t a market for the faint of heart,” said David Finkelstein, CEO of Analee. “The movements we deal with on a daily basis are almost double what the market is accustomed to.”

These interrelated but elusive developments in the mortgage market have real-world implications. For future Utah homebuyers Adams and her husband, higher interest rates have slashed the couple’s housing budget by up to 30% since June.

“It’s an endless feedback loop,” says Adams. “Things are moving very fast. It’s hard to make decisions.”

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