Falling rates: The phrase is music to a mortgage originator’s ears.
But is it possible, even when it comes to the volume stimulating effects that a favorable rate environment brings, for there to eventually be too much of a good thing?
It’s a question with immediate resonance in some other developed economies, where government bonds are trading at negative yields and pulling other market-based rates along for the ride. Rates in Denmark have fallen to zero percent for 20-year mortgages.
With global tensions building and increasingly affecting the U.S. market, industry experts are watching the rate environment evolve in ways that lack meaningful precedents. For some, recent history offers some reason to doubt the U.S. is headed toward a Europe-like outcome.
“If [negative rates] were going to happen, I think we were more likely to have experienced that during the Great Recession. Rates are low today for different reasons,” said Daniel Jacobs, a managing director at TruLoan Mortgage. “But who knows what will happen with the current dynamics in the marketplace.”
Of course, a low-probability event is by definition one that has some chance of occurring and market action suggests the sure thing is viewed as somewhat less sure.
“If you look at the implied probabilities in market-traded instruments like derivatives, it would be a very low probability. However, that relative probability is a fair amount higher than what it was even just a few months ago,” said Sean Hundtofte, chief economist at digital mortgage lender Better.com.
The idea of negative mortgage rates may sound like bottom-line Armageddon, but the conditions under which it would occur would provide built-in buffers. Mortgage companies would still be able to generate money from the spread between their borrowing rate and their lending rate or fees.
“Your real return on money or your real cost of borrowing should still be positive,” Hundtofte said.
Still, lenders would need to determine how to restructure their “financial plumbing” to account for such a rate scenario, he said. Some countries have handled negative short-term mortgage rates by adjusting principal or making payments to borrowers.
For now, prepayments are the more pressing concern for the mortgage industry when it comes to falling rates. The drop in rates this week has already driven prepayment speeds to higher-than-expected levels, said Walter Schmidt, senior vice president and manager of mortgage strategies at FTN Financial.
“Prepayments picked up tremendously as of last night, especially in the more recent 2017 and 2018 vintages. So anything that doesn’t have any kind of call protection in the cohort prepaid very quickly, and those increases were anywhere from 50% to 80% faster, which was faster than the market was expecting,” he said.
But among mortgage companies, prepayments are likely to be more of a challenge for servicing firms than lenders.
“The reality is that if you’re a servicer, rates going down are really bad news. If you’re an originator, they are great news,” Jacobs said. “For lenders, we’re generally all very happy. For now, we will certainly accept the gift of lower rates, particularly after the rough first quarter. But who knows what will happen from here.”