Why Is The Cost Of A US Mortgage So Exceptionally High?

As everyone knows, mortgage rates are very high.

This makes intuitive sense, of course. Higher interests do equal higher mortgage costs of course. Nothing new there.

What is less appreciated is mortgage rates are unusually high compared to the where those same interest rates are at, right now.

More specifically, the US 10 year Treasury bond is at 5% but the average US 30 year fixed mortgage is at 8%.

That spread or the difference between these two highly correlated assets is exceptionally wide.

This is important because the extra difference in the relationship between the two assets is driving a large chunk of the cost of buying a home at present.

The unpleasant takeaway from all this is the realization that homes are unaffordable for many Americans is at least partially a result of exceptional and unusual elevated cost of a mortgage.

The question is, of course, why?

Well, let us start with the basics around the cost of buying a house. The qualifying yearly income for a median-priced house in 2020 was $49,680. Now it’s more than $107,000, according to the NAR.​

In many large cities or coastal states it is far higher of course. You need to make over $400,000 to afford the median house in a place like Boston or San Jose or Miami.

Another way of looking at this is that the average American is spending over ~40% of their income on their monthly mortgage payment. That is a record high and over 10% more than the previous record before the Great Financial Crisis.

We have written on the issues with US housing a number of times. Most recently we discussed the problems around existing home supplies and why this was great for the sale of new homes and, as a direct result, homebuilders.

You can read that here in case you missed it.

But we want to dive deeper into the unusual nature of mortgage rates right now:

Assets like houses aren't just getting more expensive purely because of interest rates increases. They are also more expensive for other, orthogonal reasons.

These factors are difficult to talk about because they emerged from political decision making not market forces.

A policy change is at the heart of this, in other words.

Put a crudely, one of the biggest reasons mortgage rates are so unusually high is that a key buyer is no longer purchasing US mortgages on the open market.

​That buyer is the US government.​

For much of the 2008-2022 period the US government was buying US mortgages via the Federal Reserve's Quantitative Easing policy.

More specifically the US central bank was buying $40 billion of US agency mortgage backed securities every month. A mortgage backed security (MBS) is a financial product that packages together all sorts of US mortgages into a bond that can be bought and sold on an open market.

When the US government was buying that kept the price of an MBS HIGH and, as a direct result, which kept mortgages CHEAP for anyone buying a home.

That has all changed now. Mortgages may be at 8% and mortgage bonds are getting up there too as the individual mortgages that go in there gradually get higher and higher in price.

Regular 30 year agency MBS at the end of September had a coupon around 6.85%. Meanwhile the US 10 Year bond is at roughly 4.95% at the time of writing. That works out to nearly ~2% or 200 basis points.

The average spread between these assets during 2010-2020 was roughly ~1%.

Obviously, this means that the average home buyer today is paying 1% more in mortgage interest than they would have pre-pandemic.

There are some uncomfortable implications here which is likely why it gets almost totally buried. A house payment isn't a one-off thing. By its very nature, it is a long term asset.

A 30-year mortgage stretches for decades and, for many Americans, constitutes one of their biggest monthly expenses and there home becomes one of their biggest financial assets.

What this means is that the US government via the Federal Reserve helped - and continues to help - some Americans afford their homes. Those trying to buy today are obviously not receiving that same assistance.

This is pretty uncomfortable to think about when you ponder the implications going forward.

No doubt the government thought that house prices would fall in any future world where mortgages rates rose so high and so affordability wouldn't be overly affected.

That...isn't looking like a great assumption right now.

Clearly the analysts at the Fed didn't account for the historic lack of housing supply right now.

The biggest problem with this situation is that it is unlikely to go anywhere any time soon.

For one thing, it isn't just that the US Federal Reserve has stopped buying mortgage bonds either. The central bank's decision to stop buying and raise interest rates has had ripple effects throughout the economy and financial system.

American banks were other large buyers that were obviously attracted both to the positive yield that these assets contained and also the fact that there was an active and very big buyer willing to take them off your hands at a good price.

That has all changed and bank interest in buying mortgages has changed with it.

This lack of buying has only increased this year, and for good reason.

Long time readers might remember that Silicon Valley Bank was brought down by the billions of agency MBS they had bought during the pandemic that lost value rapidly.​

What does this mean? What can chance this situation?

The big challenge is no one wants to buy these assets if interest rates are still going to soar.

So, more clarity around the path for the Federal Reserve and, most importantly, the US economy you will get a more stable market and less interest volatility.

That could happen neat year but certainly seems very challenging over the next 2-3 months and very difficult to envision in the first quarter of 2024.

All of this isn't very pleasant to think about but we would really encourage you to remember that the Federal Reserve is not actively manipulating the market in favor of lower interest rates anymore.

In fact, they are doing the opposite. They are letting $120 billion in bonds from their balance sheet roll off without replacing them. This is a policy known as "quantitative tightening" rather than "easing."

There is a little discussed upside to all this. The premium for renting, not owning your home, has never been higher. Before we get howls of protests about how much rents have risen, we agree, but the price of a mortgage has risen far more.

In fact, a new monthly mortgage payment is over 50% higher than the equivalent apartment rent right now. That is the highest ever and should be a fact that is foremost in your mind before buying an exceptionally expensive house.

It might not be the deal you hope it is.

There might never be a worse time to buy a home but there has never been a better time to rent one. The first part gets a lot of press, the latter gets almost none.

So, take a breathe and take a step back. The era of government interference is over and looks unlikely to return any time soon. tThat has implications and not just for mortgage rates or putting a roof over your head. The era of free lunches is over, the age of austerity is arriving.

You can miss the former but you should be preparing for the latter.

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