Understanding Mortgage Rate futures
What are Mortgage Rate futures?
Buying a home is a crucial goal for many people, but the purchasing power frequently depends on a home loan, or mortgage. Mortgage Rate futures can be a useful tool for institutions that finance home loans, offering hedging opportunities and other risk management benefits.
The futures contracts can help mitigate the risk associated with a falling interest rate environment, which can frequently spur homeowners to refinance their loans. The contracts also enable loan providers to hedge against a rising interest rate environment, ensuring stability even when homebuyers lock in favorable rates.
Understanding Mortgage Rate futures
Mortgage Rate futures are based on the underlying Optimal Blue 30-Year Fixed Rate Conforming Index, a leading real estate pricing index representing 35% of all mortgage rate locks. With contracts listed for six consecutive months, institutions can effectively hedge longer-dated exposure.
The contact has an index multiplier of $5,000 resulting in a tick value $25 per ½ basis point ($5,000 * 0.005 = $25). The last trading day of the futures contract will coincide with the Mortgage-Backed Security (MBS) settlement dates for Class A instruments, and they're financially settled.
The futures contracts follow an index linked to mortgage rate locks, which are a key factor in mortgages, making them an ideal instrument for hedging.
Examples
Mortgage servicing businesses face risks from refinancing in a falling interest rate environment. By purchasing Mortgage Rate futures, these businesses can protect themselves against potential losses. For example, if interest rates decrease, homeowners may refinance their loans at lower rates, reducing servicing income for these businesses. Mortgage Rate futures allow businesses to hedge this risk, ensuring a steady income stream.
In a rising interest rate environment, going short futures can protect against this risk and offset the increased cost of funding home loans.
