A Little Note On Interest Rates

We’ve all watched mortgage rates drop and refinance applications skyrocket over the last couple months. In fact, the 30-year primary mortgage rate established a new all-time low of 3.29 percent in early March and continues to be low by historical standards.

Driven by rate locks in late February and early March that became closed refinance loans resulting in a wave of payoffs and fast prepayment speeds, although mortgage backed securities have been cut short due to prepayment speeds in April. The increase of this speed is up 26 percent from the month prior. That comes on the heels of a 42 percent increase in speeds from February to March.

So what does that mean for originators, banks and lenders…and why care?

The industry has seen investors and mortgage bankers enforce or change early pay off penalties. First, it all has an impact on interest rates. When loans are prepaying (refinancing) more quickly than expected, it means investors are paid off more quickly on their investment than they expected. And servicing, that they probably paid a about a point (4×1 multiple) for, vanished.

In general, investors want to hold onto their investment, as each month a borrower makes mortgage payments, they collect the principal and interest, minus servicing. The last thing an investor wants to do is pay 105 for something that pays off three months later and for which they receive 100 for, losing 5 points. Without getting into the complexities of duration calculations, when rates drop and prepayment speeds increase, it means the “rate stack” for higher rates compress, and as a result there isn’t that much of an improvement in pricing.