Historically low mortgage rates over the past year have helped many qualified borrowers refinance into lower monthly payments—a positive development for the consumer. However, this has come at the expense of current income for holders of mortgage-backed securities due to those early prepayments, while creating more uncertainty on the timing of future bond cashflows.
This significant and rapid move higher in mortgage rates has changed a few key considerations in analyzing future mortgage refinancing activity.
The most straightforward effect is that a good number of mortgage holders are now completely “out of the money.” This means that their current mortgage rate is actually lower than the prevailing rate being offered and, thus, they have no real incentive to refinance.
Second, the percent of mortgages with at least a 25 bps rate incentive to refinance has gone from almost 90% at the beginning of the year to only about 50% currently. What’s more, for those who still have a positive rate incentive, it is now much smaller (50 bps) than it was just two months ago. If these borrowers were to refinance today, they would reducing their monthly mortgage payment by much less than they could have last year.
Finally, the media effect of “all-time low mortgage rates” messaging flashed across screens last year is no longer in play. Mortgage lenders successfully motivated many homeowners to refinance with flashy and persuasive advertising campaigns. Now that mortgage rates are a lot higher, that strategy can’t be employed—with a likely dampening effect on refinancing activity.
In summary, the unique environment that led to all-time low mortgage rates and widespread mortgage refinancings has changed with the fast and furious backup in rates that started the year. This should help moderate activity going forward and will likely be a net positive for bondholders of mortgage-backed securities.