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Your Interest Rate Update

By Eric Grathwol

Mortgage and Lending with EZ Mortgages, Inc. NMLS:239756, 1160876

February 11, 2010 02:18 AM

February 11, 2010

"Greece is the word." Oh wait, I think it was "grease is the word..."

Either way, it's appropriate for today's economic environment to discuss Greece, and what it might mean to you and me, and the rates we pay for financing.

As you may have heard, Greece might be hitting the financial wall, as the country is finding it increasingly hard to refinance its massive debt. As a result, Greek bond yields have risen to over 6.75%-7% in recent weeks, and are about 3.5% higher than similar German bonds. As those debt service costs rise, it perpetuates and exacerbates the problem.

Beyond that, as a member of the EU, Greece is "required" (I put that in parentheses, because that has yet to be enforced) to maintain strict budgetary balances, which are currently way out of whack. And, those imbalances can't be cured by Greece alone without significant economic pain. It'll take either massive cuts to their deficit spending (which will plunge the country into a deep recession or possibly depression, fomenting public discontent) and/or...they need to get a bail out, whether by a cash infusion, or debt restructuring.

And, this matters to you and me because...doesn't it sound familiar?

Consider Greece, Italy, Ireland, Portugal and Spain the "subprime borrower" of the sovereign debt world. They spend more than they make, and they're basically upside down on their "house." Just like subprime borrowers defaulting on their mortgages, if Greece were to default on its debt, that would start a very unsettling ripple effect, and could cripple the credit markets again. According to John Mauldin, an analyst I enjoy reading, "the results of a Greek default would be financial turmoil. 250 billion euros (and maybe 300!) of Greek debt is in international bond funds, pension and insurance companies, and above all at banks."

That's about $350 billion to $420 billion US, or about half the dollars of our entire stimulus package, in one fell swoop. Plus, that doesn't account for any leverage on that debt (credit default swaps/insurance against that debt going bad, etc.). And Greece isn't alone. Dubai needed a bail out a short time ago. Greece could be the guinea pig, or canary in the coal mine for Italy, Ireland, Portugal and Spain who are also facing harsh economic realities and strict "requirements" within their EU member nation charters.

How the EU members (as well as financial institutions across the globe) handle Greece's troubles will set the stage for handling whichever country comes into trouble next.

And, the more investment risk there is perceived to be, the better US Treasuries, and possibly newly issued Mortgage Backed Securities are likely to perform.

That's probably why, despite several runs toward a 4% yield on 10-year Treasuries, amid unprecedented supply, prices have remained stable in the mid 3% range (it rose to 3.69% today).

And, in turn, Mortgage Backed Securities, which compete with Treasuries for investment dollars, continue to hover around historic lows of 4.75%-5%, even as we approach the Fed's stated end of their MBS purchase program.

As I've written before, I'm not sure whether mortgage rates are staying low because demand for new mortgages has subsided, so the Fed's diminished purchases are still enough to buoy prices (which keeps rates down); or whether there was a back room deal of sorts, and the likes of Goldman Sachs, JP Morgan Chase, etc. are quietly picking up the Fed's slack in the MBS market, or... if other investors are slowly stepping back into the MBS market due to the relative safety of that investment. After all, with the now explicit backing of the United States' Full Faith and Credit, Mortgage Backed Securities issued by Fannie Mae and Freddie Mac are pretty safe bets.

On that note, Fannie Mae and Freddie Mac just announced they'll be buying back a portion of their issued securities because that's a cheaper solution than making their guarantee payments. According to Nightly Business Report, Fannie and Freddie guarantee about $200 billion in delinquent mortgage securities. Good thing the US Treasury gave them that Christmas gift of unlimited credit lines.

So, from a demand side US Treasuries and mortgage backed securities may not look too bad.

The other major driver of interest rates, inflation, is basically non-existent, and deflation is still a concern. That's one reason the Fed continues to say our economy remains in a fragile state, and the extraordinary measures they've taken to help drive sustainable growth, without massive government intervention, are likely to remain in place for an "extended period."

At least now we know what an "extended period" means. It's taken to be at least 6 months. In a January 13 interview on Nightly Business Report, Bill Dudley, New York Federal Reserve President, said "So what I want to stress is extended means at least six months. It could be a year from now, two years from now. It's going to depend on how the economy develops."

The next Fed meeting will be held March 17-18. If the language in the FOMC statement still uses "extended period" we could anticipate there would be no change to the Federal Funds Target Rate until at least September (barring a sharp return to sustainable economic growth) in the interim.

At the same time, Bernanke and other Fed Board Members are out talking about the tools they have at their disposal to help reduce the money supply, which they reckon will be a more effective means of staving off inflation in the near term than raising the Federal Funds Rate. They're doing all this talking to directly telegraph their intentions, as well as their awareness of potential pit falls as they attempt to spur growth and anchor inflation expectations.

Although the Fed Funds Rate does not directly impact mortgage rates, if the Fed begins to raise their target, it's because they believe the economy is gaining traction. As the economy recovers that could (and at this point we hope does, at least a little) lead to inflationary pressures. Since inflation erodes the long term return of a fixed investment...mortgage rates would rise in fear of any pending inflation.

If the Fed's activities to tighten the money supply without raising the Fed Funds Rate directly are effective in staving off inflation, which I think they will be, we could see more than an "extended period" of this extraordinarily accommodative policy.

But wait, there's more! There are large numbers of adjustable rate mortgages which will be rolling out of their fixed terms over the next 12-24 months. With interest rates at today's levels, the underlying indices for those ARMs are very low (the 12-month LIBOR for example is around 1%, the Monthly Treasury Average is about .5%) so...ARMs that are adjusting right now, are actually providing payment relief or faster principal reduction for those who have them.

Perhaps more importantly, commercial financing relies on these same underlying indices. I'm sure the analysts at the Fed and central banks across the globe see this too. So, it would follow that they would do what they can to keep those underlying indices low, so there is less pain - and even benefit - for loans that roll out of their fixed terms into their adjustments.

Those are the main reasons why I think we might see today's level of low interest rates remain for some time. And, any further credit crisis, or even a "double dip recession" for the US or other countries could prolong our low interest rate environment.

Finally, putting further strain on our recovery is the massive volume of unsold homes. Any sharp increase in mortgage rates could slow down buyers entering the market, allowing that excess supply to sit idle for longer.

On top of that, there's the big variable of how many people who can afford to make their payments, but are upside down, will just walk from their mortgages, which would add to the over supply of vacant homes.

I saw in a New York Times story by David Streitfield that: "Using credit bureau data, consultants at Oliver Wyman calculated how many borrowers went straight from being current on their mortgage to default, rather than making spotty payments. They also weeded out owners having trouble paying other bills. Their estimate was that about 17 percent of owners defaulting in 2008, or 588,000 people, chose that option as a strategic calculation. It would cost about $745 billion, slightly more than the size of the original 2008 bank bailout, to restore all underwater borrowers to the point where they were breaking even, according to First American."

Can you smell the principal reduction?

All that said, I'm definitely in the minority thinking rates will remain low longer than the next 6 weeks. And, for each argument I outlined above, there are counter arguments as to why mortgage rates will rise sooner, rather than later. The most powerful of which is the Fed's planned termination to their mortgage backed security purchases, at the end of March.

Bottom line, what we know is that mortgage rates are as low as they've ever been. They're not likely to get lower. They will go up. It's not a matter of IF, but rather WHEN.

If you're in a position to capitalize on this cheap money - whether to buy or refinance - now is a great time to review the math behind your options.

Getting a 1% lower rate (say from 6% to 5%) on a 30yr fixed mortgage of $417,000 can save you around $100,000, over the life of that loan.

That's real money.

With that, here are your rates for this week. Please don't hesitate to call or email if you, your friends, or family have questions about financing residential or commercial real estate. Cheers! E

Conforming	Rates	Points	APR	Loan Amt	Payment
30 yr fixed mortgage	4.750%	1	4.950%	$300,000.00	$ 1,565
15 yr fixed mortgage	4.250%	1	4.450%	$300,000.00	$ 2,257
3/1 ARM	3.500%	1	3.690%	$300,000.00	$ 1,347
5/1 ARM	3.625%	1	3.835%	$300,000.00	$ 1,368
5/1 ARM Int Only	3.625%	1	3.885%	$300,000.00	$ 906
Jumbo (ask me about Super Conforming limit, per your zip code)
30 yr fixed mortgage	6.000%	1	6.126%	$550,000.00	$ 3,298
15 yr fixed mortgage	5.500%	1	5.755%	$550,000.00	$ 4,494
3/1 ARM	3.875%	1	4.055%	$550,000.00	$ 2,586
5/1 ARM	4.875%	1	5.095%	$550,000.00	$ 2,911
5/1 ARM Int Only	5.000%	1	5.250%	$550,000.00	$ 2,292

Rates subject to change without notice.
Please keep in mind, these rates and statistics are for informational purposes only to give you a sense of market movement and my opinion as to why. Although these rates exist today, based on certain qualifying characteristics, your scenario may allow for lower or higher interest rates. Licensed by the CA Dept of Real Estate, #01760965. Equal Opportunity Housing Lender. If you'd like to be removed from this list, please reply with REMOVE in the subject line. You can also use this link, mailto:egrathwol@priority1stmortgage.com and add REMOVE to the subject line. To add someone who would appreciate this information, send me their email with SUBSCRIBE as subject.