Mortgage Rates for Best Borrowers Rise as Home-Loan Bonds Slump

By Jody Shenn

Aug. 21 (Bloomberg) -- A decline in mortgage bond prices is raising interest rates on U.S. home loans, even for borrowers least prone to default.

Rates on average 30-year fixed mortgages rose to 6.37 percent this week, about the highest in six years, as yields on bonds guaranteed by Fannie Mae and Freddie Mac increased to almost the highest since 1986 relative to Treasuries. More than 70 percent of new home loans are bought or guaranteed by the government-chartered companies, known as ``prime'' mortgages.

Higher rates for the safest borrowers may exacerbate the worst housing market since the Great Depression and thwart efforts by Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson to bring mortgage rates down. The slowest-growing economy since 2001 is already shutting out some buyers and increasing costs for those seeking to borrow with smaller down payments or below-average credit scores.

``New home buyers are going to have to get credit at reasonable terms for the decline to stop,'' said Christopher Mayer, a real-estate professor at Columbia University's business school in New York. ``The price issue alone is having a very, very big effect.''

As rates rise, sellers are forced to lower prices for buyers seeking to make the same monthly payments. A rate of 6.37 percent equates to a monthly payment of $1,871 on a $300,000 mortgage, up from $1,739 when rates were as low as 5.69 percent in May, according to data from Bankrate.com in North Palm Beach, Florida.

Record High

Applications for mortgages fell 34 percent to the lowest level since 2000 in the week ended Aug. 15 from a year earlier, partly because of the increase in loan rates, according to the Washington-based Mortgage Bankers Association.

Investors are demanding 2.03 percentage points more in yield to own Fannie's current-coupon 30-year fixed-rate mortgage securities rather than 10-year Treasuries, according to data compiled by Bloomberg. The spread reached a 22-year high of 2.37 percentage points in March, before narrowing to 1.52 percentage points on May 20.

About $4.5 trillion of so-called agency mortgage bonds are outstanding, compared with $4.8 trillion of Treasuries. Agency bonds, those guaranteed by Fannie, Freddie and U.S. agency Ginnie Mae, accounted for 94 percent of home-loan securities issued in the first half of this year, up from about 50 percent a year earlier, according to newsletter Inside MBS & ABS.

By packaging loans into the securities and selling them to investors such as mutual funds, lenders receive cash to make new loans. The yields on that investors are willing to accept help determine the rates lenders need to charge borrowers to make the bond sales profitable.

New Deal

Yields on mortgage-backed debt guaranteed by Washington- based Fannie and Freddie of McLean, Virginia, widened relative to Treasuries as concern escalated that the companies may stop or slow purchases amid concern they don't have enough capital to weather the housing slump. Fannie and Freddie own or guarantee almost half the $12 trillion of mortgages outstanding.

Paulson received authority from Congress last month to pump unlimited amounts of capital into Fannie and Freddie in an emergency after the debt yields rose and their shares tumbled 90 percent from a year earlier. Freddie paid its highest yields over Treasuries on record in a debt sale Aug. 19.

Fannie, the largest mortgage-finance provider, was created as part of Franklin D. Roosevelt's New Deal in the 1930s and became a publicly owned company in 1968. Freddie was started in 1970, when the economy was strained by the Vietnam War.

A `Detriment'

Yield spreads on agency mortgage bonds narrowed in March after the Federal Reserve backed a rescue of Bear Stearns Cos. by JPMorgan Chase & Co., showing the government would act as a backstop against the failure of a large financial institution.

Spreads widened in the past three months as financial companies reduced purchases as writedowns and credit losses reached more than $500 billion, depleting capital at banks and brokers, said Scott Simon, head of mortgage-bond investing at Newport Beach, California-based Pacific Investment Management Co., the world's largest fixed-income manager.

``If spreads were to remain wide it would force prices lower,'' said Ben Hough, president of Hatteras Financial Corp., the Winston-Salem, North Carolina-based investment trust that went public in April and owns about $5 billion of agency mortgage securities. ``It's definitely a detriment to the housing recovery.''

The economy's growth is forecast to slow to 1.5 percent this year, the slowest since 0.8 percent growth in 2001.

Outside People

Home foreclosure filings rose 55 percent in July and banks repossessed almost three times as many homes as a year earlier as falling prices made it harder to sell or refinance, according to RealtyTrac Inc., an Irvine, California-based seller of foreclosure data. U.S. home prices fell 15.8 percent in May, the most since at least 2001, according to the S&P/Case-Shiller home-price index.

Wider yield spreads also reflect increases seen in other debt markets. The extra yield investors demand to own investment-grade corporate bonds rather than Treasuries rose to a record 3.11 percentage points yesterday, according to Merrill Lynch & Co.'s U.S. Corporate Master index.

``What you really need is outside people to come in to make loans that haven't been hit with all the losses that the other people have been hit with,'' Columbia's Mayer said. ``The problem is those people don't exist, at least today.''

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net