Welcome to NerdWallet’s SmartMoney podcast, where we answer your real-world money questions — in 15 minutes or less.
This week’s episode focuses on mortgage rates: why they plunged and then soared, plus what the future might bring for people planning to buy a home or refinance.
Mortgage rates are influenced by bond rates — specifically, the yield on government bonds. To understand what happened to mortgage interest rates, it helps to understand how bonds work.
The yield on a bond is the return an investor earns, based on its current price and its interest rate. A bond’s yield moves in the opposite direction of its price. When demand for a bond is high, its price goes up and its yield goes down. When demand drops, bond prices fall and the yields go up.
In February, investors started getting nervous about the potential impact of the coronavirus outbreak on the economy. They started selling stocks and buying government bonds, which are seen as a safer investment. All this demand drove up the price of the bonds. Yields — and thus mortgage rates — dropped, triggering a rush of mortgage refinance applications as people tried to lock in the new low rates. Lenders were quickly overwhelmed by the number of applications, and so they didn’t drop their rates as far as they could have simply because they couldn’t handle the additional business.
In March, investors got even more scared. They started bailing out of both stocks and bonds so they could hold cash instead. Bond prices fell and yields went up, along with mortgage rates. Meanwhile, other interest rates fell, reflecting the Federal Reserve’s cut in short-term interest rates and its efforts to shore up the financial system by adding cash.
Rates likely will drift down as lenders expand their capacity to process mortgage applications. People who want to refinance should continue checking mortgage rates and be prepared to lock in a good rate when they drop. They also should know why they’re refinancing, so they can get the right loan. If they want lower payments, for example, a 30-year loan may be appropriate. A 15-year mortgage may be a better fit if they want to get out of debt faster.
People interested in buying a house may want to proceed with caution since it’s not clear how bad unemployment will get as the economy grapples with fallout from the epidemic. Even for those whose job feels solid, it’s probably smart not to stretch too much when buying a home.
Homeowners should consider applying for a home equity line of credit, if they don’t already have one, to serve as a supplement to their emergency fund. It’s important to apply while you’re still employed, because a job loss could make getting credit difficult.
Know your goal if you’re planning to refinance. The right loan depends on what you most want to accomplish: lowering payments, reducing interest, getting rid of mortgage insurance or getting cash out.
Don’t rush into a home purchase. Real estate prices are unlikely to plunge the way they did during the 2007-2009 recession, but a struggling economy could put more jobs at risk.
Consider a home equity line of credit as a backup emergency fund. Apply while you’re still employed and don’t tap it for nonessentials.
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Sean: And I’m Sean Pyles. As always, be sure to send us your money questions. Call or text us at (901) 730-6373, that’s (901) 730-NERD, or email us at [email protected].
Liz: In the next few episodes, we’re doing something a little different. We’ll be talking about what the coronavirus pandemic means for the economy and for your personal finances with the help of our fellow Nerds.
Sean: We’ll begin with mortgage and real estate Nerd Holden Lewis.
Liz: Holden, there’s a lot of talk right now about how bad the economy could get, so … how bad could the economy get?
Holden: Before I talk about the economy, let’s talk about our company’s vision. At NerdWallet, we’re creating a world where everyone makes financial decisions with confidence. We provide clarity for all of life’s financial decisions, and that means that we give the facts. We don’t alarm people. We don’t lull people into complacency, either. Right now, we don’t know how much people will suffer financially or how long, and so ignore people who speak with certainty because there is none right now.
Liz: Since we can’t know what’s going to go on in the future, let’s talk a little bit about what’s happened in the recent past. What in the world was going on with mortgage rates?
Holden: Well, first you have to know a few things about bonds. First, when bond prices go up, the bond yields go down. Second, when investors are worried and scared, they sell stocks and they buy the safest investments around, which are bonds. Specifically, the bonds that they buy are U.S. Treasury notes and mortgage-backed securities. Third, this panic buying causes the bond prices to rise just like the price of Uber rises in a downpour. So that makes the bond yields fall. And then fourth, mortgage rates followed bond yields.
So around February 19 things started looking particularly grim, and in response investors sold stocks and they bought bonds and they pushed the bond yields and mortgage rates downward. And then around March 10 things started looking even scarier and investors began selling stocks and bonds because they were so scared that they just wanted to hold cash. Bond prices went down, the yields shot up and mortgage rates followed, and that’s where we are now.
In response to this cash hoarding, the Federal Reserve dumped cash into the financial system in an unprecedented way. Normally the Fed cuts short-term rates by a quarter of a percentage point at a time. This time the Fed cut rates by 1 and a half percentage points in 13 days. They didn’t cut rates that fast in the fall of 2008. So it’s a sign of deep concern about the health of the global financial markets.
And dollars are just, they’re the life preserver that everyone clings to, from Topeka to Seoul.
So the Fed is focusing on keeping money flowing domestically and internationally. They’re going to add cash to the financial system. They reduced the banks’ cost of borrowing, they’re going to do other types of short-term lending just to keep dollars flowing internationally. And one of the side effects, I guess you could say, is that the reduction in the federal funds rate also cut interest rates on credit cards and home equity lines of credit, but that’s not the main reason the Fed cut rates. The main reason, again, was to ease the flow of money.
Liz: OK. That makes a lot of sense. So, Holden, what should people do if they want to refinance or buy a house in the near future?
Holden: Before you refinance, ask, “Do I have to refinance?" Don’t rush into a refi just because everyone is doing it. Know why you’re refinancing. When you know your goal, you’ll get a better deal. So it might be to get the lowest possible monthly payment. It might be to get rid of FHA mortgage insurance. It might be to shorten the term so you’re paying less interest over the life of the loan or it might be to get a cash-out refinance. Know your goal.
Now, lenders got as many refinance applications, and actually more, than they could process during that plunge in rates. So they didn’t cut rates as much as they actually could have. Now that’s not greed; that is managing their workload. And so when lenders have capacity, as they process these loans and they move through the pipeline, they will drop rates to remain competitive. And so it pays to be persistent, which is to check rates every day or so, and just to jump on them when … a lender actually decreases its rates.
Now let’s say you’re planning to buy a home this year or maybe next, know what you can comfortably afford. Our home affordability calculator lets you choose a price in the quote “affordable range." So I suggest staying in that range instead of what we call stretching or aggressive. And save two to six months’ worth of mortgage payments, have them stashed away the minute you close on the loan and you get the keys. That way you’ll be able to afford an emergency repair or an interruption in income. And your lender might actually require you to have that saved. It’s called reserves.
So now what if you are planning to sell your home this year or next? Pause, don’t rush. I think a lot of people might be tempted to sell before prices start falling. Well, if prices fall, and it’s not a certain thing, it’s probable, but if they fall, we don’t know when. We don’t know how much, we don’t know how fast, and we don’t know how long. So don’t act in haste and remember that demographics mean that potential buyers will continue to outnumber sellers. People are going to be starting making babies that we’ll see in December. People are going to realize that they hate the person they live with, and those two things also will drive even more home buyer demand.
All right, so I want to talk about people’s fears. We’re not going to repeat the debacle that happened from 2007 to 2014. This recession has a different cause than the last one, which began in the housing finance industry, and then there was a direct link to the housing market. This time is different. Regulators are going to require mortgage servicers to accommodate borrowers who suffered cuts and interruptions in income. Fannie Mae, Freddie Mac, the FHA and the VA are all going to require servicers to offer relief to affected borrowers. During the housing crisis, there was a lot of talk of moral hazard, and borrowers aren’t going to get blamed this time, and frankly, neither are lenders.
Finally, let’s talk about access to cash with a home equity line of credit or HELOC. Using a HELOC in a crunch is a last resort. You could lose your home if you don’t make the payments, so always know that. But if you want to have a HELOC, to have that pool of money available to tap, apply for it while you still have income.
Sean: What if people don’t know how solid their job might be? I think that’s going to be the case for a lot of people right now and in the coming weeks. Should they go ahead and buy a house anyway?
Holden: I would say, again, don’t rush into anything, especially with the possible job precarity. I’m really interested in what’s going to happen with people who are in the middle of underwriting right now. They applied for a mortgage, they got approved, they’re scheduled to close at some point and now they’ve lost their job and their income. In the past, what has happened with that is the sale, the loan didn’t go through and neither did the purchase. And so I think that’s probably the main concern really right now, just holding off until there’s an understanding of whether that job is still secure.
Liz: Good advice, Holden, and thanks for all your insights.
Now it’s time for our takeaway tips. Know your goal if you’re planning to refinance since that will help you figure out what kind of loan to get. If you want to lower payments, consider a 30-year loan. If you want to reduce total interest paid and get the debt paid off faster, consider a 15-year loan.
Sean: Next up, don’t rush into a home purchase. Real estate prices are unlikely to crash as they did during the last recession, but a struggling economy could put more jobs at risk.
Liz: Finally, consider applying for a home equity line of credit as a backup emergency fund. Do it while you’re still employed and don’t tap it for nonessentials.
Sean: And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call us or text us your questions at (901) 730-6373, that’s (901) 730-NERD. You can also email them to [email protected]. You can even email us your voice memos if that works for you. Also, visit nerdwallet.com/podcast for more info on this episode, and remember to subscribe, rate and review us wherever you’re getting this podcast.
Liz: And here’s our brief disclaimer, thoughtfully crafted by NerdWallet’s legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general education and entertainment purposes and may not apply to your specific circumstances.
Sean: And with that said, until next time, turn to the Nerds.