There are fewer people sitting on ultracheap mortgages than you might think. As interest rates rise, mortgage bond values could decline due to refinancing slowdowns and increased prepayment risk. Conversely, if rates fall sharply, homeowners may refinance en masse, causing investors to lose expected interest income.

This dual vulnerability—sensitivity to both rising and falling rates—creates unique pressure on mortgage-backed securities. Investors holding these bonds face reinvestment risk in low-rate environments and price depreciation when rates climb. The current housing market, shaped by years of ultra-low rates, has left a smaller pool of borrowers with deeply discounted mortgages than assumed.

That reduces the buffer some expected against rate volatility. Consequently, mortgage bonds are exposed to convexity risk, where their value doesn’t move symmetrically with rate changes. Market participants are reassessing duration and cash flow models to better anticipate losses under various rate scenarios.

The outcome hinges on how quickly and severely rates shift, and whether borrowers act on refinancing incentives.