Courtesy Steven Luttman
By Steven Luttman
U.S. homeowners are sitting on approximately $35 trillion dollars of home equity. While rising values have been great for some, simultaneous higher prices and mortgage rates continue to leave many out in the proverbial cold. Should relief come, many expect it would not be in the form of falling prices, but instead in lower borrowing costs. We’ve seen the Federal Reserve lower rates on the short end of the curve with little/no impact to housing, so where else can we look? Spreads.
When we say ”spread”, we’re not referring to your favorite sports team catching six points determined by Las Vegas against a rival. Instead, it’s the difference between two benchmark rates. From a mortgage loan perspective, the significance of the 10-year U.S. Treasury yield can’t be overstated. On the surface this may not make a lot of sense. According to online lender Homebuyer.com roughly 9 out of 10 applications in 2022 were for a fixed rate mortgage spanning 30 years. With that in mind, why not focus on a 30-year instrument for a true apples to apples comparison? When taking into account refinances along with property sales, the average mortgage lifespan is actually only 8 years long. Turns out your “forever home” is rarely ever that. Keep this in mind when deciding if buying down your mortgage rate is in your best interest.
Mortgage rates trade above their Treasury counterpart due to several factors. These include servicing costs, secondary market appetite and duration risk. Equally important however, is default. While unfortunate, the chances of a household not making payments (1.73% of mortgages were delinquent as of Q3 2024 according to the Federal Reserve System) does exist. Compare this with U.S. government debt, which is viewed globally as “risk free”. The belief in repayment is in large part why there is a discrepancy.
While a strong correlation in movements between the two does exist, differences do occasionally occur. Economic conditions play a role in the discrepancy. As explained by Grey Gordon, Senior Economist with the Federal Reserve Bank of Richmond in his 2023 research paper “Mortgage Spreads and the Yield Curve”, spreads increase during times of financial uncertainty. The thesis is money flows into long dated government bonds for security, inverting the yield curve. Refinance activity from owners chasing a lower rate shortens expected term duration, causing mortgage prices to become more sensitive to short-term Treasury rates. Ultimately this leads to higher mortgage rates relative to the 10-year Treasury yield and creates wider mortgage spreads. A very complicated way of saying that evidence shows forces push up mortgage rates during times of economic slowdown.
Assuming the above is correct, we should focus our attention on where we stand today and how it ranks historically. At time of writing, the U.S. ten year is yielding 4.79%, whereas a 30-year fixed could be had for 7.05% according to Bankrate. For context, in the early 2000s the gap tended to hover near 1.75%, as it also was leading up to 2020. Generally these periods are viewed as times of economic expansion. Conversely, the spread grew as large as 3% following the financial crisis and pandemic. With a long term average of 2.0%, today’s rates reverting to the mean would decrease households’ mortgage expense. If we are headed into a period of economic prosperity however, the shift could be more substantial.
Accurately predicting the trajectory of Treasury yields is a nearly impossible task, as no one can foresee future geopolitical events, tariff and immigration policy impacts tied to the incoming administration, foreign buyer appetite and Federal Reserve quantitative easing (tightening anyone?), just to name a few of the influences. That doesn’t mean folks don’t try however. Wells Fargo, Fannie Mae and Mortgages Bankers Association anticipate 2025 year end mortgage rates in the low 6s, whereas the National Association of Realtors chief economist is a touch below six. We Realtors tend to be a “half glass full” group of people!
Given the median home sale price in our country is approaching $410,000, even a quarter point lower would provide roughly $125 of monthly savings to American households. While spreads retreating to more historical levels won’t cure our housing woes, it would offer moderate relief. For some renters, it could be just enough to finally start building home equity of their own.