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Why are interest rates so high?

By Terry Ross

Mortgage and Lending with Everest Credit Services

August 12, 2008 02:02 AM

Despite a soft stock market and a strong bond market interest rates on mortgages continue to rise. Why is this?

Interest rates on home mortgage are driven by several factors. The most obvious is the bond market and the mortgage bond rate. Fact is, while Fannie Mae and Freddie Mac were once considered almost as strong as the government, they are no longer viewed that way.

So, while interest rates remain low mortgage rates continue to rise due the amount of yield over the treasury rates that investor demand to put what are perceived to be riskier investments on their books. Given the spread of two years ago, mortgage interest rates should be in the 5.375% to 5.5% range. Instead they are roughly a full percentage point higher.

Until the market decides it likes mortgages again and demand for them increases, we will not likely see this trend change. We are also in a time of historically light mortgage production which counters the theory that lack of supply creates demand but the fact is the world's stomach is soured on US mortgage production. Virtually every country goobled US mortgage production for years until mortgage headed south. Now our production to the rest of the world is viewed as toxic waste.

Until we prove to the world that our production is once again worth buying, I think we will continue to see spreads widen and rates on mortgages continue to increase.

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Robert Smith

Byron Bank - Grand Rapids, MI

Why are rates higher? Simple. Inflationary fears. Three months ago the Fannie May 6% Bond was trading at just over 100, today it opened at 97.5. Infaltionary fears erode the value of bonds, thus leading to higher rates. If inflationary fears go the other way, we will see bond pricing improve and rates get better, regardless of demand.

Aug 12, 2008 02:13 AM

Robert Rauf

CMG Home Loans - Toms River, NJ

Rates are definately higher because of confusion in the market .... the spike in oil, along with confused numbers hinting towards recession and inflation at the same time.. and the concern of Stag-Flation... That along with what terry mentions, the sour taste for mortages... They need to prove them selves again, even with all the new loans being orriginated this year as "good" basic loans ... there is still the recent past of not knowing what was in the pools that were purchased... eventually the market will realise that mortgages are cheap for the quality, and the spread between treasuries will calm down... One other factor in the spread is the "Flight to quality" where in uncertain times money flows into treasuries as a safe haven... that is starting to dwindle now as the dollar gets stronger... it will also close the gap, but unfortunatley will not bring mortgage rates down.

Aug 12, 2008 02:36 AM

Terry Ross

Everest Credit Services - Tomball, TX

Inflation has not been driving mortgage rates, spreads over treasuries has. Last tiem we saw the 10 year around 4% we were able to offer 5.375% to 5.5% mortgages. See below

Aug 12, 2008 02:39 AM

Inflation doesnt "drive" mortgage rates, but it does drive Mortgage Backed Securities, which is exactly what fixed rate mortgages are based on-they have nothing to do with the 10 year T bill. Most times, rates will improve when the 10 year improves, but about 30% of the time, rates will move in the opposite direction of the T bill.

Aug 12, 2008 02:58 AM

Jim Crawford

Long & Foster - Fredericksburg, VA

Jim Crawford Broker Associate Fredericksburg VA

They will get much higher. Get used to it. The rates will be raise to curb inflation at some point. This is a perfect storm for our business.

Aug 12, 2008 03:02 AM

Okay, not sure of your background and not discounting any theories but I traded mortgage backed securties and Collateralized Mortgage Obligations on Wall Street from 1992 to 2000 prior to getting into this business so I think I am probably qualified to comment on this.

While I do understand mortgage rates are not indexed to the 10 year treasury as a buyer of mortgage backed securities they are spread to the 10 year and other sections of the treasury curve depending on their collateral, prepayment speeds and maturity dates and desire to own mortgage backed securities is exactly what has mortgage rates where they are right now.

Inflationary fears is also what drives the long end of the treasury curve so if there were more fear of inflation both the 10 year and the 30 year would be higher.

In case anyone doesn't know how to interpret the above graph, what is says was that last time mortgage rates were where they are today, about 6.5% in late Juneish of last year, the 10 year treasury was about 150 Basis Points, or 1.5% below them. So a 5% 10 year was supporting 6.5 on mortgages based on demand for mortgage backed securities in the secondary market. Ergo, wiith a 4% 10 year (whose rate is determined by perceived inflation, if demand were still heavy on mortgage backs we would be seeing 5.5% on FNMA and FHLMC.

You can see the steady demand of mortgage backed securities decline as represented by the widening of spreads which started in May of last year at 150 basis points or 1.5% to its current level of roughly 240 Basis Points or roughly 2.375%-2.5%.

Notice the rate on GNMA or FHA production is 25 Basis Points or 1/4 point cheaper because the perceived credit quality is better as they are backed by the "full faith and credit of the united states government and it's potentially unlimited taxation capabilites.

Aug 12, 2008 03:15 AM

Why are interest rates so high?

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