By the Numbers
Rising mortgage rates leave few borrowers in-the-money
This material is a Marketing Communication and does not constitute Independent Investment Research.
The risk of refinancing is falling as mortgage rates shift higher. Only about 5% of conventional borrowers currently have at least a 75 bp rate incentive to refinance, a threshold that covers origination costs for most borrowers. When mortgage rates were lower during the fall and winter about twice as many borrowers were refinanceable. But even that was far below the levels reached during Covid and prior refinancing waves.
During the recent refinance wave the percent of conventional 30-year loans that were at least 75 bp in-the-money to refinance peaked at about 12% in March (Exhibit 1). But this is low compared to most periods before 2022, when mortgage rates were typically lower. For example, during Covid the refinanceable portion of the MBS market peaked at 72%. And the share peaked at over 30% during two refinance periods before 2017.
Exhibit 1. Most borrowers were out-of-the-money during recent refi waves
A loan is deemed to be refinanceable if it is at least 75 bp in-the-money.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
The Fed mostly owns low coupon collateral, so private investors tend to own a larger share of the refinanceable mortgages. But excluding the Fed’s holdings does not make much difference. The share of refinanceable borrowers in March only rises to 16% after excluding the Fed’s holdings.
The convexity of Bloomberg’s MBS index also suggests that most borrowers are unlikely to refinance (Exhibit 2). The index convexity has been over -0.5 for most of the time since 2021. It dipped a bit below -0.5 when rates dropped last fall. But index convexity was regularly below -1.5 or even -2.0 before 2022.
Exhibit 2. MBS index convexity remains high
Source: Bloomberg, Santander US Capital Markets.
Loans originated in the last couple of years have much higher note rates, so the share that moved in-the-money is much larger (Exhibit 3). This shows that loans less than 2-years seasoned recently peaked around 40% refinanceable, which was not far behind the moneyness of low-WALA collateral during Covid. This may create the perception that the MBS market is as negatively convex as it was in the past despite most borrowers being well out-of-the-money.
Exhibit 3. Recent production is more rate sensitive
A loan is deemed to be refinanceable if it is at least 75 bp in-the-money.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
At current mortgage rates only borrowers in 6.0% and higher coupon pools have sufficient incentive to refinance (Exhibit 4). And in 6.0% coupon pools it is only about 25% of borrowers. This is why refinance volumes have been falling and will continue to fall unless mortgage rates go down. And some burnout has accumulated in many pools so the refi response should be somewhat muted.
Exhibit 4. Refinanceability of the largest cohorts
A loan is deemed to be refinanceable if it is at least 75 bp in-the-money.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets.
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