Mortgages Surge During the Pandemic We learn a lot about the mortgage market by understanding why it defied expectations during the pandemic. Natalie Newton Research AnalystFEDERAL RESERVE BANK OF PHILADELPHIA James Vickery Senior Economic Advisor and EconomistFEDERAL RESERVE BANK OF PHILADELPHIA The views expressed in this article are not necessarily those of the Federal Reserve. The U.S. mortgage market experienced a surprising boom in 2020 and 2021, with new lending reaching an all-time high in excess of $4 trillion per year. The boom is particularly striking in light of the challenges the mortgage market faced as the COVID-19 pandemic took hold in the U.S. in March 2020. The emergence of the virus led to financial market disruptions and a short but deep recession, prompting concerns about a potential spike in mortgage defaults and foreclosures and the possible failure of mortgage lenders and servicers. Understanding the mortgage boom is important because mortgages are by far the largest component of household debt and because mortgage market conditions significantly affect the housing market, household spending, and financial stability. In this article, we present facts about the pandemic mortgage boom and discuss the reasons why the mortgage market was able to prosper during a period of such economic uncertainty. We find that record-low interest rates, a relatively rapid economic recovery, and surging home prices all contributed in important ways to the lending boom. Underlying these outcomes, government policy actions, including expansionary monetary and fiscal policy and policies to stabilize mortgage intermediaries, played a significant role in supporting the mortgage and housing markets. We also highlight some important limits of the boom. First, the mortgage industry faced significant capacity constraints as originators scrambled to expand lending in a challenging operating environment. As a result, only part of the decline in financial market yields was passed along to mortgage borrowers in the form of lower interest rates. (Yield in this context refers to the rate of return over the life of a fixed-income security such as a Treasury bond or mortgage-backed security.) In other words, although fixed mortgage rates fell to record lows below 3 percent in 2020 and 2021, rates could have been even lower if the credit supplyhad been more elastic. Second, the low-rate environment did not benefit all mortgage borrowers equally. Mortgage rates did not fall as much for certain types of loans, such as those for large “jumbo” mortgages not eligible for government-backed credit guarantees. Black, Latino,, and Asian borrowers were less likely to refinance and thereby benefit from lower mortgage rates. This inequality in refinancing opportunities highlights the potential benefits of alternative mortgage contracts designed to allow mortgage rates to decline automatically along with market rates, sparing the borrower from needing to refinance. The Boom in Context Lenders originated $4.1 trillion in new mortgage loans in 2020, a new record and much higher than nominal lending volume in any year since 2003 (Figure 1). The torrid pace of lending continues in 2021, with an even higher $4.4 trillion of originations.’ This surge in lending was closely connected to lower mortgage interest rates. The Freddie Mac benchmark 30-year fixed mortgage rate fell below 3 percent for the first time in July 2020 and remained at or close to its all-time low through the rest of 2020 and 2021 (Figure 2).? A drop in mortgage rates boosts lending through two main channels. First, it incentivizes borrowers to refinance their existing mortgages at the new, lower market interest rates. Reflecting this incentive, refinancing more than doubled from 2019 to 2020,from $1.0 trillion to $2.6 trillion, accounting for the majority of the total rise in mortgage lending.? Second, lower interest rates increase homebuyers’ purchasing power, likely providing a tailwind for the housing market, particularly as the economy started to show signs of recovery.‘ This was reflected in a smaller but still significant increase in the volume of “purchase mortgage” lending—that is, lending used to finance a home purchase. Subsequently, the path of mortgage interest rates abruptly changed course in 2022—the benchmark 30-year fixed mortgage The interest rate rose from 3.1 percent at the end of 2021 to 6.9 percent in October 2022, a level of rates not seen since 2002. Recent data suggests this sharp rise in borrowing costs has significantly curtailed mortgage lending activity, particularly for refinancing. Mortgage Bankers Association data indicate that applications for mortgage refinances in September 2022 were 84 percent lower than in the same month of 2021, while purchase applications were 30 percent lower. Similarly, total mortgage lending in the second quarter of 2022 was down by 42 percent relative to the second quarter of 2021. In short, it seems clear that the mortgage boom of 2020–2021 has now come to an end. Initial Fears About the Mortgage Market With the benefit of hindsight, 2020–2021 was a banner period for the mortgage market, but at the onset of the CovID-19 pandemic in March 2020, the mortgage the outlook seemed highly uncertain, with the market apparently facing significant headwinds. One concern was that the pandemic seemed to presage a challenging period for the housing market. Who would buy homes in such an uncertain environment? How would lenders conduct appraisals, inspections, and closings during a period of lockdowns and social distancing? Financial markets were also extremely volatile in March 2020, making it difficult for mortgage lenders to manage risk. In particular, lenders faced large margin calls on “to-be-announced” (TBA) forward contracts, a type of financial derivative used by lenders to hedge the mortgages held in inventory while awaiting sale. This means that lenders were forced to front up additional cash as security to their counterparties after the value of their forward positions declined. These margin calls resulted in liquidity outflows of up to $5 billion.® The sharp economic downturn and spike in unemployment also raised the prospect of a surge in mortgage defaults and foreclosures similar to what was seen around the Great Recession in 2007–2009. Responding to the deteriorating economic situation, the federal government quickly stepped in to provide homeowner relief … Read more
