Banks Not Buying
Mortgage rates have been rising in 2022, with the average rate on a 30-year fixed mortgage hovering near 7%. The average was closer to 3% in January. One reason rates have spiked is that banks have stopped purchasing mortgage bonds.
This is especially true for the Federal Reserve, which is the largest buyer of such bonds. While the central bank bought up mortgage bonds throughout the pandemic’s earlier stages — in order to stimulate economic activity — those purchases were first slowed, then halted outright, in a bid to slow inflation.
As a result of this shift, there are fewer institutions and investors buying mortgage bonds. Rates on those bonds must rise in order to compensate for lower demand, which also pushes up the rate on the mortgages packaged within those bonds.
Why Things Changed
Banks and lending institutions usually don’t keep mortgages on their books after issuing them. Instead, they’re pooled into bonds and sold to investors. Many of these bonds are backed by a government guarantee.
When pandemic stimulus payments went out to Americans, banks saw their deposits increase significantly. Mortgage bonds represented a low-risk way for banks to put that cash to work. Robust demand kept mortgage bond rates low.
With deposits back down in the current macroeconomic environment, banks are holding on to less cash. And as mortgage bonds mature, banks are increasingly deciding against issuing new ones. Banks would end up losing money if they decided to sell mortgage bonds now. Because bond prices move opposite rates, many of those bonds would be sold at a loss.
Investor’s Upside and Downside
While institutions have slowed their purchase of mortgage bonds, they may still present an opportunity for individual investors. With mortgage rates up near 7%, some investors may view mortgage bonds as a way to achieve relatively safe, high-yield income. While the financial crisis of 2008 is an example of the risk, mortgage bonds have been historically safe.
There are pros and cons when investing in bonds. The upside is that they’re reliable and allow you to choose your level of risk. But they’re also typically illiquid or difficult to sell, offer limited upside, and, in rising rate environments, it’s tricky to time the purchase. Then again, in finance and in life, is getting the timing right ever easy?
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