How The MBS Market Effects Loan Pricing

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Who sets mortgage rates? Why do rates change? How often do rates change? What is a Mortgage Backed Security (MBS)? These are some of the questions often asked and following is a brief explanation of the MBS market and how it works.

Mortgage loan interest rates, and the corresponding fees or points charged for various rates, are driven by the prices of Mortgage Backed Securities (MBS). While lenders, in effect, set their own mortgage rates, how those rates are set is driven largely by the then current prices of Mortgage Backed Securities. MBS are actually pools, or groups, of mortgages packaged into securities for sale in the secondary market. One security may, for example, be made up of 500 loans totaling $75,000,000. These MBS are traded in markets in a manner very similar to stocks and other fixed income securities, and what investors will pay for these drives interest rates.

Direct lenders originate loans, while wholesale and correspondent lenders purchase loans from Mortgage Brokers or smaller lenders. Most often the different type of lenders aquire these pool of loans with the intent to resell those loans into the secondary market, packaging them into MBS. So the going price in the secondary market for loans at various interest rates influences the rates and prices a lender will offer to the public or a Mortgage Broker. Although lender and wholesaler rate sheets are typically issued no more than a couple of times each day, the value of the mortgages, or the price of MBS, and consequently the price (points) for a certain interest rate is actually constantly changing.

Unlike purchasing or selling stock, where the price is whatever it is at the moment you make the trade, wholesale and correspondent lenders generally issue a rate sheet setting forth their rates and corresponding points/premiums for those rates, and honor those rates, until the change in MBS prices reaches a certain threshold, before passing new prices on to their customers in the form of a new rate sheet. Typically lenders will issue new rate sheets as prices move more than 4/32nds to 8/32nds, or 0.125% to 0.25% points.

A few other characteristics unique to the MBS market also distinguish it from equity and Treasury markets, but the overall operation is similar. A wide range of economic, social, and political factors leads to changes in the value of a mortgage whenever new information is released. This post serves as an introduction to these influences.

As a mortgage professional, your business is greatly impacted by changes in mortgage rates. From a client relationship perspective, the implications are many. An unexpected increase in rates may cause clients to change their mind about a loan you are discussing, cause them to not qualify, result in dissatisfaction with you as their loan officer, or result in other problems. Or you may offer a rate and point quote to clients which they accept, only to find out prices have moved swiftly and suddenly, and those terms are no longer available from your lender. A sudden improvement in rates, on the other hand, if you know the possibility exists, and communicate it to your client, can create a loyal client for life when they benefit from it by receiving a lower rate. In your clients' eyes, you are the expert guiding them through the financing process, and you greatly increase your credibility with them if you are informed and help them make better decisions.

From a business and profitability perspective, your business is tremendously impacted similarly by changes in rates. Knowing in advance that rates may increase allows you to lock loans before lenders issue new rate sheets, increasing your income. Perhaps more importantly, knowing rates are improving, you may wait to lock a loan until a lender issues more favorable pricing, greatly increasing your profit. This is not to be confused with "playing the market" and simply hoping rates improve. It is simply about staying informed, with good, current, real-time prices and news about the MBS market, and making solid business decisions based on that information. In other words, you are acting only when it is to your advantage to do so.

While you may not, and need not, learn all the factors that affect MBS prices, you can benefit greatly from understanding the basics and staying informed. Keeping track of changes in MBS prices and staying on top of all the news that impacts them is a difficult and time consuming job.

While the task can be difficult, it is important for loan professionals to watch the MBS market and its movement.