Welcome to part two of our 2006 mortgage rate outlook. Last month, we gave you a primer for understanding how rate markets work and how we formulate our predictions. This month, we will discuss how Alan Greenspan’s successor Ben Bernanke may impact rate markets, summarize Wall Street rate estimates, and make our own rate predictions based on this data.
Straight-Talking Fed Means Stable Rates
Prediction 1: there won’t be a sharp rate spike in 2006.
We think this for two reasons. First, new Fed Chairman Bernanke is expected to continue and perhaps expand on Greenspan’s policy of open communication with the markets. The Fed has increased the Fed Funds Rate by 3.5%, from 1% in June 2004 to 4.5% today. But they have given clues to the extent of these increases and staggered them over a reasonable timeframe, as opposed to making sharp rises with no notice like the pre-Greenspan Fed. Second, the Fed Funds Rate is now close to the desired “neutral” level where it’s neither stimulating nor slowing the economy. This means that anything they do from here should be fine tuning rather than large shifts.
Rates For Home Equity Mortgages
Prediction 2: Home Equity Lines of Credit (HELOCs) will rise by .25% for the remainder of 2006.
HELOCs are tied to the Prime Rate, which moves in exact proportion to the Fed Funds Rate. When the Fed makes a .25% increase or decrease, your HELOC rate increases or decreases by the same percentage. With Fed Funds near neutral at 4.5%, it’s no surprise that economists aren’t calling for large increases. When the Wall Street Journal polled 56 prominent economists on Fed Funds predictions, the average of all their guesses was 4.75% by June and 4.73% by December. The difference these estimates and the current rate is where we get our .25% prediction.
Rates For Intermediate ARMs and Fixed Mortgages
Prediction 3: 7-10yr ARMs and fixed-rate mortgages will rise by .5% in 2006.
As we discussed in part one of this story, ARMs greater than seven years as well as 15 and 30-year fixed rate mortgages are not tied to Fed Funds. Instead, they follow mortgage backed bond yields. But those yields are much less widely followed so it’s hard to look at consensus estimates on them in the beginning of a year. So as a broad rate market proxy we look at consensus estimates on 10-year Treasury yields. Economists’ average end-of-2006 predictions (from the survey mentioned above) for the 10-year yield are 4.96%, which is about .5% above current market levels. The wildcard factor here is that rates could possibly drop. Here’s why: Treasury markets price in anticipated Fed Funds Rate movement in advance. So if the Fed signals rate cuts later in 2006 – which major institutions like UBS, Citigroup and Merrill Lynch are predicting – Treasury yields would drop before the Fed even cut rates. This would lower mortgage rates in this category.
Rates For ARMs of 5-yrs or Less
Prediction 4: ARMs of 5 or fewer years will rise by .375% in 2006.
ARMs of this duration also follow mortgage bond yields, but they’re harder to predict because lenders also put somewhat arbitrary risk premiums (and supply vs demand premiums) into pricing. For basic estimating purposes, we draw our estimate by comparing how 3-yr and 5-yr Treasury yields moved relative to 10-yr yields in 2005, then predict their future movement relative to 10-yr yield predictions for 2006.
Rate Insight Throughout 2006
When we began this two-part rate outlook series, we joked that predicting rate levels can sometimes feel like throwing darts at graphs on a board, but we also pointed out that there is definitely a science to it. So we want to be clear that these predictions are guesses, but after reading both articles, we hope you see that they are educated guesses.
We chose to focus our predictions on core loan programs that the majority of borrowers have. One mortgage product absent from of these predictions is Option ARMs. We left out Option ARMs because they can be tied to any number of different indices and the rate options can be tailored to a specific borrower’s objectives. But please call anytime to talk about those programs in more detail, or if you want to talk through any of the market predictions you see here.
How Did Our Predictions Do Last Year?
As for our predictions last year (Part 1 here, Part 2 here)… we said that 30yr fixed Jumbo rates would be at 6.625% versus 5.875% at the time, and they’re currently at 6.275%–we were off by .25%. We said that 5yr ARM jumbo rates would be at 6.5% versus 5.25% at the time, and they’re currently at 6.125%–we were off by .375%. Not bad, and not great either. Just like a game of darts.
Nobody can control rate markets, but we can definitely help you understand them. And more importantly, we can help you set your objectives so you can make the right financial decisions when it comes to your property investments.