Why are mortgage rates so high?
Have you been asking yourself the question, “When are mortgage rates coming down?” Well, congratulations! You found this blog. That’s because today I’m going to try to tackle one of the most challenging questions out there in the market: Are interest rates coming down, and why are they still so high?
Quick disclaimer: I am neither a lender nor do I hold a loan license, and I’m not quoting rates here. However, I’m trying to give you a little insight into the intricacies of this industry and shed light on why the rates are what they are. I’ll also provide you with some context and tips to hopefully become successful in your real estate journey.
Looking at a Jumbo Loan Purchase
Let’s take a look at the current landscape in March. For a jumbo loan purchase—typically around $1.5 million, with good credit, a solid down payment, and reserves—we’re hovering just below a 7% mortgage rate. However, it varies depending on the lender, your creditworthiness, and your down payment. Many of the quotes you’ll encounter are now in the sixes (>6%), but many of them have associated points.
Definition of a Point
You might be wondering what exactly a point is, as I’ve mentioned it several times already. For those unfamiliar, a point equates to 1% of the loan value. It is paid to the lender or bank as a fee at the closing table. Feel free to share your recent rate quotes in the comments section of the video, indicating whether there was a point attached, as this significantly impacts the overall picture.
Average Profit of a Loan
Lenders have pricing sheets, where cash up front buys down a lower rate. This is because when a bank looks at the value and profit of a loan, it doesn’t become profitable for a long time.
Let’s take jumbo products, for example, which dominate a massive portion of our market in Alameda County. Loan costs including commissions, processing fees, paperwork, and origination amount to roughly $10,500.
So, lenders need time to recoup these costs. Typically, it takes between six and nine months for lenders to recapture that initial $10,500.
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Early Payoff (EPO)
An early payoff, or EPO, happens when a loan gets paid off (usually via a refinance) prior to the lender recouping all of the upfront costs mentioned above. That’s a bad thing for the lender or bank because it means they loose money.
Why lenders taking points upfront
Lenders are assuming that rates will start to fall at some point this year. Some people think it’s in a month or two, while others think it’s in Q3 or Q4. However, generally speaking, the industry anticipates rates will come down sometime later this year.
Say, for example, that lenders make a loan to you sometime in Q1 at a mortgage rate of around 7%. Then, in six months, rates drop to 6.5%, or even to 6%. There’s a good chance borrowers are going to want to refinance that rate, right? From their perspective, thats a no brainer. Fromt he banks perspective, it’s a bad deal, especially if 100’s or even 1000’s of people do it all at once. Hence, they price these numbers a little bit higher or take a point up front. They make the loan a little more expensive because if in the future all these loans pay off en masse, they’ll have a huge loss and might end up going out of business.
So, it’s essential to recognize that the Fed rate isn’t the only thing that impacts these loans. As I’m sure you’ve heard all over the internet, what these lenders are doing is basically making a business decision. If they’re going to spend $10,500 originating a loan like this, understandably, they’ll want to make a profit. That’s where the loan point comes into play. By pricing loans with future refinancing in mind, they mitigate potential losses and sustain their business.
Summary
In summary, that’s the reason why loans are priced the way they are. Current loan pricing reflects a balancing act—anticipating future rate drops while covering upfront costs and ensuring profitability. They’re trying to price in profit for the future, assuming that a lot of these loans are going to refinance sometime in the not-so-distant future when rates come down. While this strategy is favorable in the long run, it presents challenges in today’s market. It contributes to higher costs and complexities in real estate transactions, making things harder to attain.
In short, good from a long-term perspective; not so good short-term.
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