Refinancing Rate Falls, Opening up an Opportunity for This ETF

Rising interest rates are souring the taste for refinancing transactions, according to CNBC. When rates rise, this could open up opportunities for exchange traded funds (ETFs) like the Vanguard Mortgage-Backed Securities Index Fund ETF Shares (VMBS).

As expected, the U.S. Federal Reserve raised the federal funds rate by 25 basis points recently, giving mortgage-seekers another reason to hold off. In particular, current homeowners looking to refinance were shooed away by rising rates.

Based on data from the Mortgage Bankers Association, mortgage application volume decreased by 6.8% last week relative to the previous week. Moreover, the average contract rate for a conforming 30-year fixed mortgage ticked higher by 30 basis points.

As mentioned, refinance applications saw a 15% weekly drop. Compared to a year ago, refinance applications are down over 60%.

“Mortgage rates jumped to their highest level in more than three years last week, as investors continue to price in the impact of a more restrictive monetary policy from the Federal Reserve,” said Michael Fratantoni, MBA’s chief economist.

Low-Risk MBS Exposure in 1 ETF

Just before the financial crisis in 2008, mortgage-backed securities (MBS) were a prevalent Wall Street trading mechanism before it quickly went sideways amid the subprime mortgage crisis. As such, investors were rattled by MBS while a flurry of financial regulation followed.

However, fixed income investors can still get MBS exposure with low risk using VMBS. The fund also comes with a low expense ratio of just 0.04%.

VMBS seeks to track the performance of a market-weighted mortgage-backed securities index. The fund employs an indexing investment approach designed to track the performance of the Bloomberg U.S. MBS Float Adjusted Index, which covers U.S. agency mortgage-backed pass-through securities.

To be included in the index, pool aggregates must have at least $250 million currently outstanding and a weighted average maturity of at least one year. All of the fund’s investments will be selected through the sampling process, and under normal circumstances, at least 80% of the fund’s assets will be invested in bonds included in the index.

Overall, VMBS:

  • Seeks to provide a moderate and sustainable level of current income.
  • Invests primarily in U.S. agency mortgage-backed pass-through securities issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).
  • Moderate interest rate risk, with a dollar-weighted average maturity of three to 10 years.

For more news, information, and strategy, visit the Fixed Income Channel.