From his words in the books of Proverbs and Ecclesiastes, it’s clear that King Solomon, the wise son of David, despised wealth without wisdom, and the unjust treatment of the poor – who, because they lived honest, prudent lives, were more worthy of regard than those who had money but no discernment. That’s an important concept for today’s world of real estate investing, in which major mortgage lenders may still be misleading borrowers in the quest for a profit.
The virtually unprecedented current low mortgage interest rates are well known. It’s a good time to invest, buy a home, or refinance existing properties because, it’s said, rates will only go up. Because the Federal Reserve continues to buy up mortgage-backed securities at an astounding rate of billions of dollars per month, many expect rates to stay artificially low. On the other hand, these securities are backed by US Treasury bonds, whose performance in the global market also affects rates, and changes on that level can also affect whether mortgage rates start to swing upward.
But according to a 2012 DealBook article, there’s another factor that may play a role in determining not just where mortgage rates are currently holding in the market, but also what rate a bank or other lender actually offers a borrower applying for the loan.
Most major lenders, including banks and the government backed Fannie Mae and Freddie Mac, don’t hold mortgages for long. Those mortgages are sold into the bond market, which ensures a government backed guarantee of repayment. The difference between the bond and mortgage rates represents the lender’s profit on the transaction – the bigger the “spread” between the two, the larger the gain for the lender.
Until recently, that spread has remained relatively steady – around 0.75 percentage points over the past five years or so. But since the end of 2011, the spread has widened significantly, averaging 1.4 percentage points. That’s because bond yields have fallen farther than the mortgage rates banks are charging borrowers.
This means that banks and other lenders may not be passing on those low bond market rates to borrowers. Instead, they’re taking a bigger cut and increasing the size of their own gains on the transaction. Explanations for this range from the benign to the deliberately manipulative, citing increased demand for mortgages because of low rates and a recovering housing market, or a deliberate strategy on the part of lenders to increase profits on mortgage lending.
In any case, rates passed on to borrowers still remain historically low. But because of the mortgage-bond link and the performance of US backed securities in the larger market, most mortgage industry experts doubt those rates will sink any lower – and, given the interplay among all factors, they may eventually rise. For those following Jason Hartman’s recommendations for investing in income property, it’s important to bring King Solomon’s prudence and wisdom to the the transaction, do your homework — and shop around for the best rates you can find. (Top image: Flickr/dobrev)
The Solomon Success Team