We May See Mortgage Rates Fall to 3.5%

According to Freddie Mac (FRE), the average 30 year fixed rate mortgage dropped for the 10th consecutive week to a new low of 5.01%. This is the lowest rate reported by Freddie Mac since they began keeping track in 1971.

Rates have moved sharply lower over the past two weeks to all time lows, despite the fact that the 10 year treasury bond did not move to new lows. The traditional rate differential between the 10 year treasury and the 30 year fixed rate mortgage has disappeared due to the mortgage crisis and other factors. Risk is now priced higher across all credit markets, including mortgage backed securities [MBS].

The Federal Reserve's direct purchases of mortgage backed securities initiated late last year was successful in its goal of lowering mortgage rates. The Fed's direct purchases of MBS has stabilized the mortgage market and lowered rates. There are arguments being put forth that due to the Fed's intervention, mortgage rates have artificial price support. Nonetheless, if the historical yield spread between the bond and the 30 year mortgage is re-established, we may see a 30 year fixed rate in the 3.5% range. Something to think about for those contemplating a mortgage refinance.

Last week, a borrower with excellent credit, necessary income and home equity was able to obtain a par rate of 4.5%. The question of whether the Fed is manipulating mortgage pricing at this point or how long such price support can last is somewhat irrelevant. The major fact to keep in mind is that the Fed appears to be relentless in its campaign to drive down mortgage rates. If the Fed can stabilize the MBS market we may be looking at mortgage rates in a range we never thought possible a short time ago.

30 year fixed rate mortgages in the mid 3% range would cause a huge refinance surge. Keep in mind that over the past five years, homeowners had multiple opportunities to refinance in the low 5% range. Unless the borrower is taking cash out, it usually does not pay to refinance for less than a one percentage point reduction. At 3.5% rates, it would make sense for almost every homeowner with a mortgage to refinance again.

Disclosure: no positions

Comments

[patio:]

Any estimate of when we might see the 3's? Feb.?

Jan 12 10:42 AM

[carey_jim:]

Don't consider this to be a prediction but merely a caveat emptor:

IF deflation kicks in big time then mortgage rates could go even lower than 3.5.

And if investor perception begins to factor in deflation then savvy borrowers will wait for mortgage rates to fall.

This is common sense, of course, but there is not harm in reminding people of the obvious.

Jan 12 11:32 AM

[SoCalGal:]

The author is right...the Fed is the 800 pound gorrilla buying MBS. Every day now, it appears we must be cognizant of the Fed's purchases, if any. Excerpt from this morning's Mortgage Market Guide, a bond market advisory service...

<< Although Bond prices are down, they may rebound a bit later if the Fed steps in with some buying. Although there is no news so far today on their buying activity, that could change as the day unfolds. The Bond's price is trading within a wide range, between resistance at $101.37 and support at $99.97. Because the range is so wide--and because we are near the center of this range--prices may be especially prone to swings and whipsaws both higher and lower intraday. Therefore, it may be wise--although difficult--to be a bit patient, and ride out some of the price blips. >>

The other side of the coin is that China has lost its appetite for U.S. debt.

www.iht.com/articles/2...

For every trade, there's a buyer and a seller. Perhaps the Fed figured out that China's not the 800 pound gorrilla anymore and, to avoid total disaster, they hatched this plan to step into China's trading shoes. Will the Fed's participation be enough to offset China's departure from the bond market? Hmmm.....

Jan 12 03:25 PM

[User 143167:]

If the housing market can only stablize at 3.5% 30Y mortgage rate, it bodes ill for the whole economy in the years to come. It is either hyperinflation or bust scenario.

Jan 12 04:03 PM

[vodka_tonic:]

3.5 would be really bad on multiple levels....it's a devaluation of the currency and all asset classes from current levels. stability is key, but the fed is kinda ignoring that for now !

Jan 13 04:24 AM

[xmplary:]

A prediction without a time limit is certainly bound to come true, if not in our life time, some day! I guess I will believe it when I see it. Certainly would be a boon to refinancing and housing market.

Jan 13 12:07 PM

[igggy:]

All this means is that in 5-10 years will have to bail out the 'good' banks. They will still be holding 3.5-4% mortgage loans but might have to pay 5% or more on customer deposits. Which won't be sustainable and lead to another crisis. Or maybe they'll be allowed to play with leveraged instruments again to generate profits. Nothing good either way. We had this scenario in the 70s.

Jan 13 12:41 PM

[Bill W.:]

Holy Moley! Now I get it! The fed is holding a huge amount of toxic MBS from the banks and the only way they can make these debt instruments viable is to induce inflation into the mix. If interest rates do, indeed go to 3.5 % then it is not a strech to see home prices increase by quite a lot.

Jan 13 01:21 PM

[khemmara:]

Wait a minute.First the govt rip off the consumers 800 billion dollars and throw a lifeline to the bankers and the bankers turn around and charge us the consumers at the rate 4.5 to 5% for a 30 years mortgage.Giving the fact the Fed Reserve rate .25%.I think its dawgone unfair to us the consumers.We as the consumers should demand the rate for a 30 years mortgage The bankers should charge the consumers right around 2 to 3% at the most.

Jan 13 02:36 PM

[Whippet:]

Wow- is the fix going to be worse than the cure, or what? Any bank lending at 3.5% for thirty years is setting itself up to have a slew of new problems once an inevitable inflationary period occurs as it doesn't take a genius to realize that collecting interest lower than the rate of inflation is a sure loser. Anyone with equity in a home would be a fool to not cash-out refinance in this sort of environment- with the writedowns on your taxes, we're talking effectively a 1-2% real cost for the loan. Even if you just stick the money in inflation-adjusted I savings bonds, you'll win big time in the end unless we're in a deflationary cycle for 10 years (and do believe that Helicopter Ben Bernanke won't allow that to happen.)

Jan 13 03:56 PM

[Chris B:]

The banks stopped buying these things long ago because they don't yield enough to offset the default risk. From an investor's perspective, a bundle of mortgages is at least as risky as a bundle of junk bonds, but the mortgages yield 2-3% after servicing costs and the junk bonds yield 12% - both only IF you experience no defaults. No private investor could make any money off MBS. Only the federal government is supporting this market and preventing double-digit mortgage rates as we saw a couple decades ago. If the market was allowed to take its course, mortgage rates would be at least 10% for buyers with great credit, and home prices might be cut in half.

Disturbing thought: When inflation inevitably returns and the fed (hopefully) tries to contract the money supply, will they stop buying mortgages? After all, buying mortgages has the same expansionary effect on money supply/velocity as the other open market activities that we would expect the fed to curtail to fight inflation. Will the fed be forced to chose between high inflation and a housing market collapse?

Jan 13 05:01 PM

[2bz:]

"No one" in the U.S. will hold the mortgage to maturity. Let's not kid ourselves; that would be the rational thing to do. If the Fed succeeds in reinflating the housing market people will be itching to ditch their properties at "break even" and get into "bigger and better" properties as long as they will be able to cover the payments for some time. The average time people hold on to their residences is 7 years AFAIR. I think that the banks will be OK as long as the inflation does not get too out of hand, i.e. banks refi mortgages at 3.5% now and get paid back when interest rates reach current levels ~5%, provided a healthy or newly exuberant housing market.

Also, if people don't have incomes, they will not be able to refinance unless lenders continue to offer "liars' loans".

The best, but not a short term, solution to our problems is to figure out how to flip the tables on the rest of the world and in particular on Asia. Namely, find goods or more likely services which we can provide to the exclusion of other countries for which there would be a high demand and which we could manufacture/provide relatively cheaply. Our business people and lawyers are increasingly working in places like Abu Dhabi is an excellent start. Obama's plan to reinvigorate our scientific research may be a good idea too in the longer term, provided that we succeed.

Jan 13 05:21 PM

[Socialism c...:]

Meaningless. What people have got to realize is that there are simply TOO MANY houses on the market. We got to a point where people were flipping houses, owning investment properties, etc. -- who shouldn't have been doing so. They aren't going to reenter that situation. Or at least most won't...until prices drop much, much more significantly. People have lost too much money and can't afford those nth homes. One is now enough. Lowering of rates makes affordability of the first mortgage better for the subset that was struggling with that, but far too many of these homes were 2nd or 3rd homes...and simply aren't going to be bought no matter the interest rate -- because no buyers EXIST.

There's a big difference between a deal needing to become attractive enough to lure out existing would-be buyers...and needing a buyer to exist in the first place. Many of those who do not own homes in the U.S. either do not want to, or simply cannot afford to, no matter the interest rate!!

I'm predicting an average drop of 30% in home pricing yet to come, in the next 2 years.

Jan 13 05:41 PM

[joof:]

By most measures housing pricing in most markets is now at a reasonble level vs. income - of course after a catastrophic decline . Add the lower rates, and why not buy?

Fear.....

Jan 13 06:56 PM

[bick2:]

The total number of houses is not the issue. The problem is that the price of houses went through a bubble and is still coming down. A lot of people were priced out because of the bubble. Yes 3.5% helps a lot IF you are a new, qualified buyer or are above water and are looking to refi. But if you are a new buyer you have got to be thinking this is not the bottom yet so hold on for a while yet.

But if you are below water 3.5% doesn't help you refinance. To refi you need to come up with 20% equity. THIS is the biggest problem. Underwater owners.

On Jan 13 05:41 PM Socialism cannot compete! wrote:

> Meaningless. What people have got to realize is that there are simply
> TOO MANY houses on the market. We got to a point where people were
> flipping houses, owning investment properties, etc. -- who shouldn't
> have been doing so. They aren't going to reenter that situation.
> Or at least most won't...until prices drop much, much more significantly.
> People have lost too much money and can't afford those nth homes.
> One is now enough. Lowering of rates makes affordability of the
> first mortgage better for the subset that was struggling with that,
> but far too many of these homes were 2nd or 3rd homes...and simply
> aren't going to be bought no matter the interest rate -- because
> no buyers EXIST.
>
> There's a big difference between a deal needing to become attractive
> enough to lure out existing would-be buyers...and needing a buyer
> to exist in the first place. Many of those who do not own homes
> in the U.S. either do not want to, or simply cannot afford to, no
> matter the interest rate!!
>
> I'm predicting an average drop of 30% in home pricing yet to come,
> in the next 2 years.

Jan 13 07:55 PM

[cdg:]

Other variables for the individual to consider are the mortgage interest deductions for a 3.5% mortgage versus what they are writing off with their current mortgage, and what the need for the write-off will be down the line depending on their income. Are those refinancing retiring soon, or in ten years? Do they have defined benefit plans working for them and can budget this new amount, making their monthly payments lower? The low rate sounds very appealing to many, but there will be "unintended consequences" to the banks if inflationary period sets in, as cited by others. Perhaps someone can develop a model for a 15 year fixed rate refinancing deal, and see whether that better suits borrower and lender both. There are benefits initially to individuals, but there can be problems for the system in the long term.

Jan 13 11:28 PM

[sickofthehype:]

True, however, as inflation and the economy rebound, rates will rise, and a new portfolio of higher interest rate loans will offset the lower ones.

In addition, the balance sheets that have been hit hard by REO's will be adjusted as they are sold off.

One thing people forget is that the banks must maintain in reserves 100% of the loan balance on any home they foreclose on. This is the issue. Once REO's are sold off, reserves increase, freeing more funds to lend.

This will happen, it's a matter of time, as banks don't make money sitting around propping up balance sheets.


On Jan 13 12:41 PM dtv999 wrote:

> All this means is that in 5-10 years will have to bail out the 'good'
> banks. They will still be holding 3.5-4% mortgage loans but might
> have to pay 5% or more on customer deposits. Which won't be sustainable
> and lead to another crisis. Or maybe they'll be allowed to play with
> leveraged instruments again to generate profits. Nothing good either
> way. We had this scenario in the 70s.

Jan 14 10:32 AM

[DC Housing ...:]

Awesome. I have an even better idea. Let's have the government buy houses and just give them away. We can use the $1 trillion stimulus money and print more if we need to. Everyone in America gets a free house. Krugman said we needed something BIG and Pelosi thinks all Americans deserve a McMansion. We get the best of both worlds.

Jan 14 01:13 PM

[User 265729:]

If they were zero it wouldn't help. People can't pay for the main course, let alone the tip!

Jan 14 05:19 PM

[Alpha Econ:]

Refinancing activity pick might happen once again, but the real $1 trillion question is whether these, already, historically low rates are spurring new mortgages uptake or even refinancing with some equity withdrawals. So far (see: trueeconomics.blogspot...) this has not happened. De-leveraging process for HHs' balance sheets must move deeper and we are not out of the precautionary savings hoarding yet. My view - property will continue falling in value, sales will continue languishing and retail will continue deteriorating until the above two forces play out and consumers will feel that it is safe (not simply cheap) to borrow again.

Jan 14 06:36 PM

[{5U}:]

The government can provide as much cheap credit as possible to buy houses but the driving factor will be houses getting to the right price.

And isn't low rates what got us into this mess in the first place?

Jan 15 01:17 AM

[User 305589:]

such rates would imply that the govt in essence guarantees the mortgages. if they don't rates will creep back up as soon as the fed stops propping them up by buying them with taxpayer money.
i don't see a big problem for the next few years.
but afterwards, well: who is going to guarantee the trillions of govt debt, including the fannie, freddie bonds, mortagages, medicare , medicaid obligations, pensions, guarantees for municipalities (of course these will kick in pretty soon, once the first countys or even states are under threat of defaulting)? who is going to buy the many billions of government debt that will have to raised just to pay the interest on the trillions of principal? it is already the biggest ponzi scheme in mankind's history and is set to grow at a rapid clip.
Do you really believe anyone is going to lend the u.s. govt money at 2 percent a couple of years from now? but people would have to do that or else the govt is losing out on each and every of these 3.5% mortgages.
I know, very few care, understandably these days, but 10-15 years from now the dollar will be a shadow of its own. you think times are bad now and the next year? just wait for 2020...

Jan 15 07:56 AM

[xom-only:]

you gave me the hook,( so i sound like i know what i am talking about ) when you pointed out the current discrepency between the 10 yr spread and the 30 year spread. i have been telling everyone that i know and will listen ( my wife and dog mainly) that we won't reach a bottom and stabilize untill 'all' home mortgages have been refinanced down to less than 3.5% and people like me can go out and buy rental homes and get them financed for 70% of 'appraised or what i paid' value. i think obama's plan is just trying to refinance the banks, the banks, loan the home builders enough to give them some time to wait for the consumer pool of buyers to be reestablished, make the insurance com. solvent again, and then last but not least the consumer must be put in the same relative position by refinancing at a significantly lower rate. the baby boomers will never go back to buying harleys again ( and i am not short hog). i'd say <3.5% would be stabilization of the patient and then we'll worry about inflation and the next patient country.

Jan 15 09:07 AM

[RatWatcher:]

I am sad to say I agree with this statement. People will still buy to the PAYMENT, not the actual value of the property. Ideally, changes in the price of money (interest rates) shouldn't change the value of the home itself (principal). But it does.


On Jan 13 01:21 PM Bill W. wrote:

> If interest rates do,
> indeed go to 3.5 % then it is not a strech to see home prices increase
> by quite a lot.

Jan 16 01:01 AM

[2bz:]

On Jan 13 11:28 PM cdg wrote:

> Other variables for the individual to consider are the mortgage interest
> deductions for a 3.5% mortgage versus what they are writing off with
> their current mortgage, and what the need for the write-off will
> be down the line depending on their income.

Nonsense, what consideration should a tax rate less than 100% have on refinancing at a lower interest rate? Your post only makes sense if the tax rate is greater than 100%.

Jan 22 11:47 PM