Will All-Time Record Low Rates Go Lower?

As you read this quarterly mortgage market update, you may still be reeling from the figures on your first quarter 2009 investment statements. Markets have been bruising since the credit crisis began in August 2007, with stocks declining approximately 40% since last Fall alone. During this time, economic and financial market updates have come to dominate press headlines.

All investment strategies—in stocks, bonds, property, commodities, etc.—require long-term perspective, and this is mostly absent from daily market press coverage. As financial news has taken center stage, chatter tends to outweigh insight, which can cloud your financial decision making process.

Your traditional investments may just need time for the market to rebound. As for property investments, rates are at record lows, and the mass chatter might have you believe they’re going lower. So below is an explanation of how rates work so you can properly evaluate a home purchase or refinance this year.

What Rates Does The Press Cover?
News about mortgage rates comes fast and furious, and unless otherwise specified, these reports all follow the same format. Every week, Fannie Mae and Freddie Mac release average nationwide rates on Conforming loans up to $417,000 made to borrowers with at least 20% equity in their homes. These rates don’t apply to loans above $417,000 and don’t apply to FHA loans. These Fannie/Freddie rates include borrower-paid points to buy the rate down, and the average points paid are usually buried at the end of media stories. Also, these reports discuss rates from the previous week, which means rates discussed in the media are expired before the stories even run.

It’s imperative in this strict loan approval environment that borrowers understand rates are based on specific client and property profiles, and most rates reported in the media are highly generalized versions of outdated data.

How Are Rates Derived?
In fact, mortgage rates expire several times per day. Rates on Conforming loans up to $417,000 (and up to as high as $729,750 in higher priced regions) are based on open market mortgage bond trading, so rates drop as bond prices trade higher, and rates rise as bond prices trade lower. Mortgage bonds trade wildly in the current economic environment, causing rates to rise and fall all day, every day.

It’s worth noting that Jumbo rates on loans above $417,000 (or above the $729,750 cap in high priced markets) are presently set by lenders based on borrower creditworthiness. In the past, Jumbo loans were also packaged into mortgage bonds and their rate levels would also fluctuate based on mortgage bond trading. But securitization of Jumbos isn’t happening in this harsh credit climate so Jumbo rates tend to be more stable day-to-day but they’re higher than Conforming rates.

How Does The Fed Influence Rates?
Between mid-September 2007 and mid-November 2008, the Federal Reserve cut rates nine times for a total cut of 4.25%. Yet rates on Conforming 30-year fixed mortgages began and ended those exact same periods at 6.25%. This is because the Fed Funds Rate is a rate for overnight bank-to-bank loans, not a consumer rate. Intermediate and long-term mortgage rates are based on trading in mortgage bonds, which don’t have a direct correlation to moves in Fed rates.

So on November 24, 2008, the Fed announced that they’d buy mortgage bonds to drive bond prices up and rates down. The Fed has committed to buying $1.25 trillion of mortgage bonds through this December and has spent about 35% of that budget so far. Conforming 30-year fixed rates now trade in an all-time record-low range just above and below 5%.

Fed vs. Openly Traded Rate Market
The Fed mortgage bond program will help keep rates low, but consumers shouldn’t assume rates will drop significantly from current levels. Here’s why:

The Fed’s mortgage bond buying goal has always been to elevate bond prices to certain levels to keep rates nice and low. But they are only one participant in the massive mortgage bond market. Private investors have been saying since November 2008 that their goal is to buy mortgage bonds before the Fed and sell at a profit after the Fed drives up the prices. Private investors will sell more and more as the Fed uses up its $1.25 trillion budget, which means Fed buying and private selling may work to even each other out over the course of this year.

Rate Advice For Buyers and Refinancers
Now that you know how mortgage rates work and why it’s possible rates might not go significantly lower, we can look at current rate levels. Right now Conforming 30-year fixed rates with zero points (on loans up to $417,000) are around 5% with a +/- .375% trading range, meaning they can go from 4.625% to 5.375% as mortgage bonds trade daily. Below are tips for homebuyers and refinancers in this volatile environment.

As a homebuyer, your core objective is to obtain the best price for a property in your target area. Rates rise and fall in shorter cycles than home prices so even if rates are at the top of the range shown above when you close on a home purchase, if you get the home at a significant discount, the math almost always works in your favor. You need to conduct neighborhood-level home price analysis with your realtor, and run some rate versus price numbers with your mortgage advisor.

As a refinancer, if your circumstances require you to execute now, you are locking record-low rates that you’ll be thrilled with in a couple years. Everyone who has closed a loan since last December should still be within the market trading range. If you choose to wait, just make sure you understand this quarter’s cover story about the current rate cycle. You’re not likely to hear this in the media, but it’s the real story on how rates work.

As for locking refis, it’s a trader’s approach: pick a price target within the range of the past four weeks and lock as the market trades into this range. Greed can be gut wrenching, so understand the ranges and be realistic.