When mortgage rates rise, fewer homeowners refinance. This means that mortgage-backed securities will be paid off slower than investors expected. At the same time, yields on other bonds, including risk-free Treasury notes, are rising. Mortgage investors grow concerned. All things being equal, they would rather own higher-yield securities than lower-yield securities, just as you'd rather have a higher-paying job than a lower-paying one.
So investors sell their lower-yield mortgage-backed securities and buy higher-yield ones. And mortgage interest rates rise with the higher yields. When this cycle begins—the cycle of selling bonds to chase higher yields—it can feed on itself, creating powerful updrafts in rates. That's what happened on Black Wednesday.
Now that rates are higher, should homeowners give up on refinancing?
"It's really a function of what is the rate they have on their mortgage, and how long they intend to stay in the home," says David Adamo, CEO of Luxury Mortgage, a Stamford, Conn.-based mortgage bank that lends nationwide. If someone still has a mortgage at more than 6 percent and plans to stay in the home for more than three years, "there's economic justification to refinance under today's rates," Adamo says. At the time he was speaking, rates were around 5.625 percent.
Christopher Cruise, senior loan officer for GOTeHomeLoans.com, says a rapid rise in mortgage rates can be a good thing if, as usual, rates fall back. Indecisive borrowers jump off the fence. "Anything below 5 percent, they're going to come flooding in," he says. "They say, 'Oops, I missed it this time. If rates come back down, I'm not going to miss it now.'"
You can't entirely blame fence-sitters for not locking when rates were so low during much of the spring. Because so many people were refinancing, it was taking the overwhelmed banks seven to 10 weeks to get loans from application to closing. Because a lot of lenders charged a fee for locking a rate longer than 30 days, borrowers often floated until they were comfortably inside the 30-days-till-closing window.