Duration Extending?

If the experts are right, then mortgage duration should begin extending again as interest rates edge upward this year.

Forecasting interest rate movements is always a dicey proposition, but most economists believe that economic growth is strengthening, and that should push rates in an upward direction. The Mortgage Bankers Association, for example, predicts that the average 30-year mortgage rate will hit 6.5% by the end of this year, up roughly 75 basis points from the level in mid-February.

At 6.5%, home purchase lending would account for 80% of the home loan market and refinancing would drop to 20% from a current level of about 50%, according to Dale Westoff, a prepayment expert at Bear Stearns.

In addition to putting a clamp on refinancing, higher rates would likely slow housing turnover, because some potential trade-up homebuyers would have trouble qualifying for financing as the cost of borrowing rises.

Those two factors, especially the drop in refinancing, will increase mortgage duration, Mr. Westoff told Mortgage Servicing News. But he predicts the extension of mortgage life cycles will be more modest than the market saw last summer, when rates went from a low of about 5.25% in June to over 6% two months later. At that time, the average mortgage duration jumped from less than a year to three-and-a-half years in a short time period according to prepayment models, Mr. Westoff said.

Today, a 50 basis point rise in rates would only cause an extension of the average mortgage life span by about six-tenths of one year, he said, resulting in a "much more orderly kind of move."

The reason that mortgage duration will move more modestly this time is that fewer loans are exposed to refinancing in the first place, he said. When rates hit 5.25% last summer, 75% of the outstanding universe of home loans were eligible to refinance and improve their rate and terms. In February, with rates hovering at about 5.75%, only about 45% of outstanding loans were vulnerable to refinancing.