Double-Edged Sword for Mortgages as Market Fears Drive Rates Down

The recent global market turmoil could be good news for banks and mortgage lenders if a further drop in long-term interest rates sparks another wave of refinancing.

It also could spell trouble for lenders that have not properly hedged the value of their servicing rights, however, and the benefits of lower rates are far from assured.

U.S. Treasury yields, which mortgage rates are tied to, slumped to a four-month low Monday, as investors remained anxious about China's woes and the slower pace of global growth and sought a safe haven in government bonds. The 10-year Treasury yield fell as low as 1.95% during the session, down six basis points from late Friday.

For now, mortgage rates would have to drop at least 25 basis points or more from recent levels to spark a major wave of refinancings.

"A big chunk of 2013 and 2014 loans are just out of the money to refinance," said Scott Buchta, head of fixed income strategy at Brean Capital.

The stock market plunge has some investors assuming that the U.S. economy is heading into a recession, with the potential for massive layoffs at manufacturing firms that could be crippled by lower commodity prices.

Ivy Zelman, the CEO of Zelman and Associates, a housing analytics firm, said the sell-off hitting homebuilders, mortgage insurers, title companies and financial stocks, is an overreaction. With yields on 10-year Treasury notes falling to 2%, the market is assuming much slower economic growth ahead, she said.

"It's more about slowing economic growth than about rates," Zelman said. "There's a lot of knee-jerk reactions."

The biggest concern is that manufacturers would start laying off employees, resulting in job losses.

"If people lose their jobs, they can't buy a house," Zelman said.

Uncertainty about whether the Federal Reserve will raise short-term rates in September or delay a rate hike until December or early next year has contributed to the market volatility.

Some nonbank mortgage servicers will be aggressive at soliciting borrowers to refinance. Since most banks and mortgage lenders are seeing a steady flow of home purchase and refinance volume, they may be loath to lower mortgage rates much further, since doing so would cut into profits.

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