Yields and Fixed Mortgage Rates

Mortgage rates and the bond market have a nice little marriage; 9+ times out of 10, when bond rates rocket higher, fixed mortgage rates move up too.

As seen in the chart below, 5-year fixed rates and bond yields track each other fairly closely over time. In fact, on a monthly basis going back to 1980, there’s been a 97% correlation between the two.

5-year_Posted_Mortgage_vs_5-year_Bond_YieldIt’s not a perfect marriage though, as we’ve seen recently.

On March 9, mortgage rates and the bond market unexpectedly kicked their relationship to the curb. Yields went way up, and mortgage rates actually fell slightly.

Banks are behind this pleasant divergence. In a rush for market share, they’ve started ‘buying’ customers with, what some say, are “unsustainably low” mortgage rates. (See “Banks Wage War”)

Put another way, big banks are pricing 5-year fixed mortgages at unusually low spreads above bond yields.

This is a party for homeowners. You don’t find 5-year terms at 70-85 basis points above the GOC very often.

Hopefully this “unsustainable” trend can be sustained well into the future. But odds are, spreads will normalize after the spring (at least until the banks decide to ‘give away’ mortgages once again).

This is far from the first time that fixed rates have drifted apart from bond yields. From late 2007 to mid 2009, spreads were way out of whack. The credit crisis kept mortgage rates high while bond yields dropped to multi-decade lows.

5-year_Mortgage_Bond-Yield_SpreadEverything needs to be put into perspective though. Despite deviations from the norm, the norm isn’t dead yet.  In general, lenders still need to pay bond rates for mortgage money, and they still have similar costs as before.

So when yields go one way, and fixed mortgage rates go the other, remember they’re still married. They’re just temporarily separated.

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Sidebar:  Speculating on long term rate direction is like flipping a coin. It’s almost certain you’ll be wrong as much as you’re right.

Yet, when you see a big move in yields, on a short-term basis, there’s usually predictive power there. 

This comes into play when you want to lock in a rate on a new mortgage.  If you see yields jump 1/4 point, for example, it’s usually worthwhile to move quickly and get a rate hold.  If you don’t, there’s a good chance you’ll pay a slightly higher rate. 

Paying a fraction of a percent more isn’t the world, but the extra interest does add up over five years.

Whenever we see yields move in big spurts, we write about it here. When you see these stories, it helps to remember:

  • The short term isn’t the long term. If you read that rates may go up next week,” that’s a short term statement. Economic news could come out two weeks later and drive rates the other way.
  • The relationship between bonds and mortgage rates isn’t perfect, and even short-term forecasts won’t always be accurate.

That said, over the long run you’ll be right far more than you’re wrong by assuming fixed rates will track bond yields.

  1. This is a win win situation for the mortgage consumers. It is just a matter of time before mortgage rates and bond yeilds relationship will be back on line and we will see fixed mortgage rates start to go up.

  2. Something tells me the big banks are not too concerned about historically low spreads between the bond rates they pay and the mortgage rates they get in return from their consumers, since they are probably offsetting any potential loss relative to historical average profits by getting borrowers to lock into 5 year fixed terms in record numbers, rather than allowing many of these people to go the VRM route and likely save big bucks by paying record low (prime-linked) rates for at least the past year and a half and then likely a year or two into the future.

  3. “the big banks are not too concerned about historically low spreads” : Quoted from Jackie Jr.
    Jackie you are essentially saying that big banks are not concerned about profits.
    Having worked with a bank I can tell you that banks watch spreads very closely. They base internal transfer pricing on external market costs when setting mortgage rates. The rates we are seeing cannot be sustained by any single bank for long.
    You might also be interested to know that variable spreads are currently wider than 5 year fixed spreads. If I were a bank I would much rather someone take a VRM. Not only will the bank make more in the short term but most variable borrowers will inevitably lock into worse fixed rates later.

  4. Question for Rob or anyone else who would care to take a stab:
    Is there a stat on the percentage of VRM holders who eventually lock in their rate at some point during their term? And does this differ by term, borrower profile, etc.?
    thanks,
    Al R

  5. I have a VRM with BMO at P-0.3 for another 2 years. I can convert it to fixed at any time. Does anybody in similar situation with variable mortgage is thinking to lock in? And at what rate?

  6. My plan was to wait until the next time posted rates go up. Sounds like as good a time as any. I don’t think fixed mortgages will go any lower after that.
    I can lock in today at 3.89% and I’m wondering if I should find a different lender that is cheaper. My penalty is $1181 and I don’t renew for 3 years. Any ideas are appreciated!

  7. After much debate with myself, I chose to lock in at 3.69 for 5 years a couple of weeks ago. I had renewed with a VRM in January at prime -.2 for 5 years.
    My thinking was lock in now when interest rates are incredibly low, or not lock in at all. I chose to lock in now for the cost certainty. My wife and I just had a baby, so we are down to one income for a few years. So for me, locking in was really just managing my risk. I also saved a little money by waiting, as the best I could do in Jan. was 3.79 fixed for 5.

  8. Sort of, but as CMT pointed out in the post on TD’s 10yr fixed rate, just because something is historically low doesn’t mean that it makes financial sense over other options.
    It very well may make sense, but it also may not.

  9. Hi Alex & Skipper,
    It might be worthwhile to call a mortgage planner and ask them to run some amortization scenarios.
    Ask them to compare your present option (factoring in any penalties and discharge fees) with the best available alternative.
    This will indicate if it makes sense to lock in with you current lender or go elsewhere.
    Cheers,
    Rob

  10. Hi Al,
    I thought we had this stat but I can’t find it. Now it’s bugging me. I will make it a mini-mission to find out because it would make for an interesting story.
    Cheers,
    Rob

  11. Got this message from my BMO mortgage contact:
    “I can try pushing the discretion on our 5 year low rate mortgage t0 3.55%, however this is a limited time and would need to get an application into the system soon before rates change or our discretion gets pulled back from our pricing desk. This could change at any time of day.”
    That’s 3.55%! On a five-year! It doesn’t get any better than that … too bad I’m not in the market to buy now.

  12. LOL. I love the hedged wording: “I can try…”
    In my experience this is a standard bank tactic. They get you to complete a full application on the assumption they will “ask” for a rate exception. Then they don’t get it and they try to sell you a higher rate.
    If you are asked to fill out an application make sure the person is confident you will get the rate promised.
    ANY broker or bank salesperson should be able to pre qualify you and tell you if you meet the requirements for a given rate.

  13. I’m trying to decide whether it’s worth paying $20k to break my 5yr term of 5.449 with 3 yrs remaining so I can get 3.55% on a 5yr. It works out that if I keep paying the same amount as I do now (accelerated bi-weekly)that after 3 yrs I’d owe the same as if I had done nothing. The benefit is that I would have 2yrs remaining at the 3.55% rate and based on what people are saying in 3 yrs the rates could be much higher.
    Another option is if I wait until mid April 2011 my penalty would no longer be IRD based and I’d only have to pay a $5600 penalty (3 months interest) but again rates are supposed to rise so I’m worried this is my only window of opportunity to get a low (3.55%) rate in the years from 2013 -2015. What are your thoughts ?

  14. Hi Matt,
    Thanks very much for posting.
    In general, it’s difficult to make borrower-specific recommendations in the forums because we invariably lack all the borrower details required.
    For any questions specific to your personal situation (like should I refinance?, should I go fixed or variable?, etc.) you may be best served by calling or emailing a mortgage planner you trust. You can often get the answers you require with just a brief phone call. Alternatively, if we can be of assistance please don’t hesitate to contact us directly.
    For more limited and general questions we’re always happy to answer here, time-permitting.
    Cheers for now…
    Rob

  15. How does one practically track bond yields to determine which direction mortgage rates will take? Bloomberg, Yahoo Finance?

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