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Nominal mortgage rates have hit a series of all-time lows over the last year, consistent with the path observed for other rates including both short- and long-term US Treasuries. As shown in Exhibit 1, although the interest rate on the 30-year fixed rate mortgage (FRM30) has dropped nearly 0.75% or 75 basis points (bps) since the beginning of 2020, the 10-year Treasury fell by more than 1% (or 100 bps) over the same period. This difference between the mortgage rate and the 10-year Treasury, commonly referred to as the primary mortgage spread, has widened to approximately 250 bps in 2020, among the widest historical spreads ever observed.1,2
[Figure omitted: see PDF.]
In order to understand the dynamics underlying the primary mortgage spread and in particular what is behind the recent persistent widened spread, it is useful to further decompose this spread into two constituent spreads. The first, the secondary spread, measures the difference between the return paid to investors on mortgage-backed securities (also known as the current coupon yield or CCY30) and the rate on the 10-year Treasury.3,4 Intuitively, changes in this spread are driven by changes in relative investor appetite for MBS versus Treasuries. The second, the primary–secondary spread measures the difference between the FRM30 and the CCY30. This spread represents the additional components of the mortgage rate beyond the rate paid to investors, including servicing fees, guarantee fees (gfees), and excess servicing. Exhibit 2 illustrates that both secondary and primary–secondary spreads have increased following the Treasury rate declines in the wake of the COVID-19 outbreak beginning in March 2020 and that both remain elevated relative to their pre-Financial Crisis averages. However, the secondary spread has compressed somewhat over the last few months, while the primary–secondary spread remains wide.
[Figure omitted: see PDF.]
In this article, we provide an empirically-based investigation of the historical and recent dynamics of mortgage spreads, with key implications for the outlook for mortgage rates and originations.
DRIVERS OF MORTGAGE SPREADS
As discussed above, mortgage rates can be thought of in a basic sense as a build up from the 10-year Treasury as follows:
[Formula omitted: see PDF.]
Here, FRM30t refers to the 30-year fixed rate mortgage rate, 10Yr Tsyt