Lower mortgage rates may be good news for refinance-savvy consumers. But for the nation's portfolio lenders and investors in mortgage-backed securities, it's another story.
Claus Lund, senior vice president and head of mortgage asset management at BankAmerica Mortgage Co., is predicting another "nasty experience" for investors in mortgage-backed securities, as low rates trigger a new round of refinancing by the nation's homeowners.
With the Federal Reserve expected to cut short-term rates again this year, Mr. Lund expects rates on 30-year mortgages to dip below 7%, and trigger a "refinancing boomlet."
Investors will respond by demanding higher yields, Mr. Lund said. And mortgage spreads, which widened 25 to 30 basis points in 1995, can be expected to widen again this year.
That is bad news for first-time homeowners and the low-income to moderate-income end of the market, Mr. Lund said.
Low long-term rates could also spell trouble for many portfolio lenders, particularly if the yield curve remains flat.
In the 1992 to 1993 refinancing boom, Mr. Lund recalled, ARMs continued to be quite competitive with fixed-rate loans, because short-term rates were several points below long-term rates.
"People played the whole yield curve - they would take ARMs, they would take fixed-rate mortgages," Mr. Lund said. "If the yield curve does not change back to a more normal curve, we will see total activity in the fixed-rate market. Everybody will take a fixed-rate mortgage," he said.
ARM lenders will find it hard to compete and their portfolios may well shrink, he said. Even BankAmerica's ARM portfolio would likely suffer, he said.
Just in time for the refinancing boom, BankAmerica is rolling out fixed rate loans with prepayment penalties. Consumers will get slightly better rates in exchange for agreeing to pay a penalty if they refinance in the first three years of the loan's life.
The bank already has such penalties in place on many of its ARM loans, and Mr. Lund said loans with prepayment penalties prepay only one-third to one-half as often as other loans.
While BankAmerica expects to hold its new fixed rate loan product in portfolio at first, Mr. Lund expects loans with prepayment penalties to catch on eventually with all refinance-weary investors.