Thursday, July 03, 2008

Shopping for Mortgages

I am currently shopping for a California Mortgage. It is a little weird--the best pricing relative to the yield curve seems to be a 5-1 ARM. 30-year fixed rates are absurd--around 350 bp above 30 year CMT. While part of this is pricing the prepayment option, it also implies a truly implausible default probability for a prime mortgage.

One would think five-year ARMS would have higher default risks, so it must be about interest rate risk--perhaps buyers of 30-year Treasuries are not so worried about duration matching as buyers of 30-year mortgages? Anyway, the mortgage market in California currently strongly resembles the Canadian Mortgage market.

4 comments:

Uncle Billy Doesn't Do Home Loans said...

Prof. Green, have you checked out amerisave? It is *very* hard to go wrong with this outfit. They are the brainchild of Jack Guttentage (www.mtgprofessor.com)

The problem with shopping and pricing loans is twofold: 1) apples and oranges 2) bait and switch

Upfront mortgage lenders and brokers almost completely eliminate both of those issues. If you're looking to shave an eighth, you're probably better off going with a umb, but for bread and butter loan, UML is really tough to beat.

Of course, if you're a "Friend of Angelo"...

Anonymous said...

Default risk on a 5/1 is only slightly higher than a 30F. But interest rate risk is higher on jumbo loans than conformings (using last year's terminology) so it features prominently in California pricing. Currently, spreads on jumbos to Treasuries are really high, and no one knows how long this will last. And prepayment speeds are really low, and no one knows how long this will last. So one is sure exactly HOW to duration match a 30F jumbo, producing large spreads, which tends to incurease the uncertainty, which tends to increase the spread. Repeat as necessary.

Anonymous said...

oops - that should read "No one is sure" not "one is sure." Dropping the negative can really hurt, can't it?

Anonymous said...

There is also some assumption that most buyers (which is everyone other than people in tenured academic positions and federal judges) will move at least every 5 years.

I just spoke with a U.K. mortgage broker (now in the U.S.) who notes that they were writing 7 year rate guarantees and then reset rates after that on the assumption that the majority of customers will not hold the loan longer than that due to moving.