Earlier this month, I did an interview with the San Francisco
Chronicle about repeat no-cost refinancing in a declining rate
environment. The piece came out January 4, the day after minutes from
the Fed's last 2012 rate meeting were released. Those minutes revealed
more bias toward ending Fed support of low mortgage rates than
previously thought, and rates rose immediately.
So is the free refi boom over? Not quite, but we're getting close.
Below I explain, first by defining "free refi," then by offering some
rate market context.
In the Chronicle piece, I explained how a smart repeat refinancing
strategy is to do no-cost refinances while rates are dropping, then when
rates are at the bottom, doing a normal-cost refinance (which has a
rate that's .125% to .25% lower than a no-cost refinance) or even pay
points to buy a rate down to capture the true lowest possible low.
Here's an excerpt:
Likewise, Julian Hebron, vice president of RPM Mortgage in San
Francisco, said, "As rates continue to drop, refinancing repeatedly is
quite common in the past 24 months."
Many clients chose no-cost refinances, in which lenders pay all
closing costs in exchange for the borrower taking a rate that is
one-eighth or one-quarter point higher than the current market rate, he
"No-cost refinances are the best play in a declining-rate
environment," Hebron said. That's because they allow borrowers to
refinance multiple times without digging into their own pockets.
"We've been advising clients not to pay points for most of 2012, on
the belief that rates are remaining at existing lows or dropping," he
Up until now, this no-cost refinance strategy has worked for
borrowers nationwide. But the Fed minutes were the first reminder to
markets and consumers that rates won't stay this low forever.
The December 12 Fed meeting statement left
markets thinking the Fed would keep overnight rates near zero and
continue their agressive mortgage bond (aka MBS) buying to keep mortgage
rates ultra low until the unemployment rate drops from current 7.8% to
6.5%. After that, rates were in true record low territory for the rest
of December-the perfect environment for the no-cost refi, and most
lenders were running full tilt through the holidays to capture and close
these loans for borrowers. But when markets got the detailed minutes from that meeting on January 3, it was a different story: "several" members advocated to slow or stop MBS buying (aka QE3) by the end of 2013.
Initially rates rose by .125% on this news. As noted above, a free
refi is accomplished by the consumer taking a rate that's .125% to .25%
higher in order for the lender to credit the closing costs. So this
early-2013 rate spike eliminated that free refi option until this week
started. MBS markets rebounded Monday through Wednesday, rates dipped,
and were back to no-cost refis at record lows.
But Thursday was a wildly different story as MBS markets sold off
sharply (FNMA 30yr 3% coupon down 45 basis points to 103.94), causing
rates to rise again. My friend Matt Graham, lead MBS analyst at
Mortgage News Daily, explained it well before U.S. data hit Thursday:
On Tuesday Japan's Economy Minister Amari threw a bit of cold water
on the perception of a rampantly weakening Yen, but this morning has
said that a weaker yen shouldn't be much of an issue until it his 100.0.
It was trading as low as 88 yesterday and it now up to 89.44 following
Amari's comments along only account for a portion of that movement
however. They were most damaging as the catalyst for a snowball in
European markets leading toward higher rates. That merely started the
snowball rolling. Europe gave it a bigger push.
Rumors that the ECB is considering tighter collateral requirements,
which sparked concerns about paybacks on the ECB's LTRO's (Long term
refinancing operations) at the end of the month. Think of that like a
"reverse QE." Just like when the Fed pumps money into the system to
lower interest rates and encourage lending, if European banks are
pumping money back out of the system (by paying more of it back to the
ECB), the implication is for higher rates.
German Bunds moved from 1.47 to 1.55 by 6am New York time. That's a
big move! Treasuries were following in relative lock-step, but as is
typical during European hours, the movements in Treasuries were an order
of magnitude smaller than Bunds, moving up only 5.5 bps vs the 8bp move
That was cause for celebration as it seemed that the massive,
unexpected overnight weakness was already in the process of bouncing off
a ceiling at 1.86%. Fannie 3.0 MBS had opened at 104-10-a supportive
floor earlier in the week-and were hoping to hold there, or close to it.
Domestic bond markets were certainly on the back foot, but with some
hope of a bounce back with the help of cooperative U.S. data.
But Thursday's U.S. economic data was much stronger-lowest jobless claims in 5yrs, and new home construction at 4yr high-which kept bonds lower and rates higher through the close.
Net result: we end a wild week with rates up .125% again.
Which means rates are still near record lows if you're doing a
normal-cost refinance, but a no-cost refi will be higher than it was
during late 2012 (and higher than any quote you may have gotten from
your lender early this week).
So where do we go from here?
There's a case to be made that rates won't spike sharply because mediocre global economicfundamentals and
fiscal paralysis in the U.S. and Europe generally bode ok for bond
markets and rates. And if we look back to those Fed minutes indicating
Fed MBS buying may end this year, some disagree, including Goldman
So what should we make of the FOMC minutes, which suggest that most
Fed officials expect to end QE3 by late 2013? Not too much, in our view.
For one thing, it is important to remember that the outlook for
monetary policy depends on the outlook for the economy. The midpoint of
the committee's "central tendency" forecast for real GDP growth in 2013
is 2.65%, which probably implies growth of 3-3½% in H2 given the obvious
headwinds in H1. If that turns out to be too optimistic, as we suspect
it will, QE3 will probably last longer than Fed officials currently
expect. More importantly, the minutes have a tendency to mislead at
times when the range of views on the FOMC is large because they paint an
overly "democratic" picture of the decisionmaking process. Even under
Ben Bernanke-a much less autocratic chairman than many of his
predecessors-it is ultimately the Fed leadership that drives the
decisions, and it is their views that we need to identify. This is
difficult to do with confidence in the minutes, but we suspect that it
was mainly the leadership that "...emphasized the need for considerable
policy accommodation but did not state a specific time frame or total
for purchases." Based on our own expectations for the economy and our
understanding of the reaction function, we continue to expect that QE3
will run through 2013 and-at a reduced pace-2014 as well.
That said, it's not just about waiting for the Fed to ease off this
multi-year MBS trade that began when QE1 MBS buying was announced in
November 24, 2008. The Fed didn't actually buy any MBS until January
2009, but in those weeks from Thanksgiving 2008 to New Years 2009, rates
dropped a whopping 1.25% as investors piled into MBS ahead of the Fed.
Bond king Bill Gross said at the time:
PIMCO's view is simple: shake hands with the government; make them
your partner by acknowledging that their checkbook represents the
largest and most potent source of buying power in 2009 and beyond.
Anticipate, then buy what they buy, only do it first: agency-backed
mortgages, bank preferred stocks, and senior bank debt; Aaa asset-backed
securities such as credit card, student loan, and auto receivables.
These have been well-advertised PIMCO strategies over the past 6 months
but there are others in clear sight.
The operative words here are "do it first." Just like global
investors piled into MBS in 2008 and caused rates to drop 1.25% before
the Fed spend one dime on rate stimulus in 2009, the exit will work the
same: MBS markets will start selling long before the Fed formally
indicates their exit, and rates will spike accordingly.
All of this is a long way of offering a wake up call to rate shoppers
"holding out for better" because the best levels have been tested many
times, and better is unlikely.
It's also a reminder to those who've done a few no-cost refis over
the past couple years to do one last check to see if it's mathematically
sound to do one final fix of your rate before the market turns.
Julian Hebron runs the San Francisco offices of RPM Mortgage, and founder of influential housing blog The Basis Point. Follow him on twitter: @thebasispoint.