What do you say when someone asks "Why are interest rates going up so fast"" or "Where do you see interest rates in a few months if I choose to wait to buy"? Mortgage rates are a very hot topic right now, especially as they have spiked up over 5% again after being as low as 4% a few months ago. Buyers are also getting very confused and frustrated why rates are rising so fast. Understanding what to say when anyone asks you about interest rates is going to be very important these days, because if buyers know that rates are going to continue to rise, many of them on the fence will make a decision to buy now. Here are 4 tips to help you answer any questions anyone has about interest rates.
1. Mortgage rates are traded everyday just like stocks
Understanding what determines mortgage rates is quite simple. Mortgage rates are traded everyday as mortgage bonds (MBS) just like stocks. They either go up or down in price on a daily basis. Here is a picture of a mortgage bond trading chart below. When bonds (green line) are trading lower mortgage rates (red) are higher and when bonds are trading higher mortgage rates are lower.
When bonds trade lower (green), lenders raise their rates and distribute "Reprices for the Worse" (see chart below) and republish these higher rates to the public. This trading of bonds directly correlates to the mortgage rates we see everyday from lenders.
When Bonds Trade Lower Mortgage Rates Increase
What economic events force rates to go up or down?
So what causes mortgage rates to go up or down and mortgage bonds to trade higher or lower? These are tied to some fundamental economic activities that take place everyday in our markets, by understanding these you will now be able to determine what direction rates will probably go for your clients.
2. Stocks vs bonds Mortgage bonds compete everyday for investors dollars in the open markets. Stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky. Remember: When there is weak economic news (higher unemployment etc), this normally causes money to flow out of Stocks and into more stable Bonds helping Bonds and home loan rates improve. When there is better economic news (lower unemployment, more homes sold etc) this normally has the opposite result, so investors will put their money into more risky stocks, thus causing mortgage rates to increase. Economic data has been improving recently so this is why rates have been rising. It is an interesting dynamic that generally worse economic news is good for mortgage rates!
3. Inflation is going to be a problem soon because of all this money that is being printed to pay for Government spending. So how will this affect mortgage rates? The bottom line is that as inflation increases, home loan rates will rise too. That's because lenders know that a rise in inflation actually diminishes the value of the money they receive over the life of a loan, as the money they receive for payment simply won't go as far. So when they see changes in inflation or even anticipate a rise, they increase their interest rates to make up for the loss in future buying power that will happen as a result of inflation.
4. The 800 pound gorilla in the room..US debt
As ths US continues to add to its already burgeoning $1.5 Trillion dollar deficit, inverstors around the world who lend the US money by way of buying treasuires and bonds are going to demand a higher rate of return for the financing of US government spending. Because the larger the US debt level grows the higher the chances of a default sometime in the future, and so investors will price this accordingly. Just 3 months ago the 10 year bond rate (the 30 year fixed mortgage rate follows this) was at 2.5%, today it is at 3.75%..you can thank The Fed and Ben Bernanke for this, as they have been adding to the US debt load by way of printing money via their "QE" Quantitative Easing programs, so investors are now demanding a higher return on their investment. So until the US gets its fiscal house in order and tackles the deficit, long term rates will continue to rise.
Rising rates affect buyer budgets and loan approvals
It is also very important to show buyers that rising interest rates will eat away any savings they could get from waiting for prices to dip again. Eventually a buyer needs to make a decision about what is most important, either their monthly payment or "finding the bottom of the market in terms of price". Higher interest rates are going to affect buyers budgets dramatically too, while also affecting any current offers or loan approvals they may have. Lenders have tightened qualifying ratios recently, so make sure any increase in payments will still get approved.
For example, a pre approval that a buyer has had for 3-4 months at 4.5% that stretched their budget is no good when rates jump up to 5% or 5.5%. Perhaps they will not be able to afford the higher payment anymore and they will need to start shopping all over again for lower priced homes. Remember as rates increase 1% a buyer loses 10% in purchasing power. For example the monthly payment increases $255 a month for a $417k loan going from 4.5% to 5.5%, this is a car payment for some people and a lot of money for a family of 4 or 5. Make sure you are having conversations with buyers advising them that if rates do continue to rise, they need to know what their new higher payments will be and if that new higher payment still fits in their budget. Otherwise all those days spent writing up approval letters and showing homes at a particular price range will be to no avail.
What are rates at now? They are still at 40 year lows!
With rates now back up over 5%, the question is where will they go from here? In their most recent rate forecast, MBA economists said they expect rates on 30 year fixed loans will climb to an average of 5.5% and higher by the 3rd quarter of 2011 and to an average of 6.1% during the final 3 months of 2012. But on a positive note, they are still at historical lows when you compare them with interest rates over the past 40 years. Here is a good chart below to show buyers a little history lesson on interest rates. So for anyone looking at buying a home right now, you can let them know they can still qualify for the lowest rates in 40 years.
So for anyone looking at buying a home right now, you can let them know they can still qualify for the lowest rates in 40 years. There is no doubt that the interest rate markets are going to be very volatile for the next few months. If you ever want to discuss interest rates or what direction they may be going, please feel free to contact me. I study market information daily and subscribe to two mortgage bond companies that track mortgage bonds live everyday, so this ensures my clients always get the most accurate information and the lowest rates available.
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