It’s been a tough sled for rates going on 3+ years now. In 2022, we went from 3% rates in January to 8% rates in October. It was a wild ride for sure, but the most bizarre part is that the 10 Year Treasury topped out at 4.30% in October. We are currently at 4.39% with average fixed rate around 6.875%, so if the 10 YR was lower then than it is now how were mortgage rates near 8%??
The answer, mortgage spreads and Term Premium. And to take a step back, remember, the Fed DOES NOT change mortgage rates. It helps and they tend to go in the same direction, but it’s the US 10 Year Treasury rate that mortgage rates track the closest.
As you can see in the chart below, even though the 10 Yr yield has stubbornly stayed between 4.20% & 4.50% since July of 2023, mortgage rates have actually been lower most of this year comparatively due to the spreads.
So what goes into the spread? Prepayment risk (the risk that a newly opened mortgage will be refinanced more quickly than the banks want). Since rates haven’t come down as much as everyone though, and they aren’t expected to go back into the 4’s, this has lowered the spreads.
The other big portion of the spread, is the Term Premium. This is the level of risk investors are willing to take when they purchase bonds due to “perceived” risks. Right now and over the past few years the uncertainty of inflation, fiscal deficits, and now tariffs, have kept this elevated. But as you can see below, it’s still lower than 2023 & 2024.
We don’t need the 10 Year yields to go below 3.5% to get better rates. We need a 10 YR between 3.5%-4.0% and the mortgage spreads to normalize back to their long-term historical average of 1.75%-2.0%. I firmly believe it will happen, because of the law of averages. However, we need to continue to be patient!
