Mortgage Rates at 4.5%?!?!

As early as next week, we may see 30 year mortgage rates as low as 4.5%! 

As we speak, the U.S. Treasury is evaluating different proposals and ideas to further stimulate the ailing mortgage and housing market.  One key proposal offered up by lobbyists in the financial industry would involve the Treasury buying up mortgage-backed securities from Fannie Mae and Freddie Mac in an effort to set a target rate of 4.5% by manipulating the supply of mortgage-backed securities.

If this proposal is ultimately carried out by the Treasury, this would amount to an unprecedented action of direct involvement by the U.S. government to lower mortgage rates.  In a normal market, the government does not intervine in the mortgage market - mortgage rates are determined by the supply and demand of mortgage-backed securities, which is ultimately controlled by demand from global investors and market conditions. 

But obviously this market is anything but normal right now. 

Over the last several years, the spread (difference) between the 10 year Treasury note yield and the 30 year mortgage rate has averaged around 1.8%.  This reflects the perception of the difference in risk between the two by investments in a normal market.  But on Wednesday of this week, the 10 Year Treasury yield fell to as low as 2.65% due to the increased demand caused by a flight to quality by investors.  However, the average 30 year mortgage rate is still hovering around 5.5%, which represents a spread of almost three points.  This increase in spread is a direct result of investors' increased perception of risk and defaults related to mortgage-backed securities. 

In other words, if we were in a normal market right now, 30 year mortgage rates would probably already be in the upper 4% range.  But the higher perception of risk has kept the rates higher.  So the only way to make them go lower at this point would be unprecedented action by the Treasury to buy up these securities which would, in theory, drive mortgage rates lower. 

At this point, there's no guarantee that this is going to happen, but I stongly believe this is the Treasury's best option as it stands right now.  If it does happen, the resulting lower rates would greatly stimulate the housing market and also cause an unprecedented refinance boom.   

If rates do drop into the mid 4% range, homeowners and potential home buyers would be smart to lock in their rate and not hold out for continued improvements.  In my experience, people tend to hold off during times when rates make huge drops thinking they can get an extra 1/8th of a percent if they just wait a little bit longer, only to get left in the dust when rates often quickly make upward market adjustments due to the cooling off of the shock value of breaking news. 

I really don't like predicting what's going to happen with the markets.  Let's face it.  Guys like Jim Kramer and the gang on CNBC make tens of millions of dollars a year predicting the markets and THEY ARE WRONG MORE THAN HALF OF THE TIME.  I am no Jim Kramer, BUT PAST EXPERIENCE TELLS ME that when and if this is announced by the Treasury, the shock factor of the news could POSSIBLY drop rates immediately by up to one full point.  But they often adjust higher once this news is fully absorbed by the markets.  A great example of this is when the news broke in September that the government was bailing out Fannie Mae and Freddie Mac.  Rates almost immediately dropped by .875% to 5.25%, but they only remained that low for a couple of days before levelling off above 6%.  

In other words, those that were smart and locked when the news broke got lucky.  Those who sat on the fence hoping for an extra eighth of a point missed out big time.   

But who knows.  This is direct government intervention in the fundamentals of supply and demand of mortgage-backed securities.  It might be different this time.  We may see a temporary minor shock and then more of a gradual reduction over a few weeks to a few months. But if the rates happen to drop substantially in a short period of time, you'd be smart to jump on them.  The flood of new loans could quickly increase the supply of mortgage-backed securities once again, which would, in turn, start to drive rates back up.  This will not be a permanent policy of the Treasury.  The mortgage market in the U.S. is literally Trillions of dollars, and the Treasury would run the risk of massive inflation if it were to write a blank check for these securities.  Mark my words.  This will be a "limited time only" event.  How limited?  I have no idea.  But it definitely won't last forever. 

I believe that the government has little choice at this point to take direct action that will directly benefit consumers and current home owners.  This would be one of the best stimulus packages they could give us all for Christmas.

It's also worth noting that this is not a bailout for homeowners who are already behind on their payments or who otherwise can't qualify for a mortgage.  Those buyers are still left to negotiate with their current lenders for loan modifications or other products offered under the TARP plan.  It's also not going to help people who can't qualify for a mortgage based on their income and credit score.  Also, buyers looking to refinance their current mortgage must either have enough equity to cover the higher loan amount that will result from rolling in the new closing costs, or bring money to closing.  Another option may be to premium price the rate and have the lender pay some closing costs.  This keeps the closing costs lower but increases the interest rate.  But still, a rate in the low 5% range for little or no lender closing costs is still a great deal. 

But potential homebuyers and those that have current rates above 5.75% may benefit greatly if this proposal is approved.  As far as I can tell with the data available to me, 30 year mortgage rates have never been 4.5% (unless, of course, the buyer paid a massive amount of points to buy down their rate). 

Check back for additional breaking details.  You can be sure that I will update this blog as soon as the news breaks!  The Treasury is expected to make a final decision as early as next week. 

**UPDATE** - I have received a few emails from people who have mentioned that this program may only be eligible for PURCHASE transactions and not refinance transactions.  I have heard conflicting information in various news reports today, and everything is essentially speculation at this point.   We will have to just wait and see what the Treasury decides to do before knowing the answer to this quesiton...

If you have any additional information, i strongly encourage you to leave a comment at this point.  Thank you everyone!