Mortgage Rate Outlook for 2010

Like it or not, we have a mortgage market that is controlled by the federal government. FHA and VA are both government programs. Fannie Mae and Freddie Mac are controlled by the Federal Housing Finance Agency and owned by you and me. These entities control about 90 percent of mortgages being offered today. The rest of the market includes the jumbo loans, almost DOA but showing signs of life, and hard-money loans.

FHA began having a much more important role when the loan limits were lifted from the relatively low $362,000 to $417,000 to match the limits used by Fannie Mae and Freddie Mac. When the limits for “high cost” areas were increased to $729,750, the loan limits were also lifted for FHA. This made FHA a real player in the market.

The result has been a dramatic increase in FHA’s share of the mortgage market. Previously FHA did less than 500,000 loans per year, and the volume is now over 1.2 million. Data for June 2009 puts the FHA share of market at 24 percent of new home sales and 14 percent of existing home sales.

Notably, the important thing is that you can still get an FHA loan with a relatively modest 3.5 percent down payment. This is much more generous than other programs. It is also the cause for concern as we will discuss at a later time.

From a rate standpoint, all three entities are governed by the market for long-term obligations. In order to provide the basis for a stable housing market, an important part of the government’s stimulus package included support for the mortgage market. The Federal Reserve announced in late 2008 that they would buy up to $1.3 trillion in mortgage backed securities. About $1 trillion has been spent so far. The effect of this has been to provide substantial liquidity at reasonable rates.

As a result, it appears that the housing market is getting better with sales of existing homes likely to exceed 5.5 million in 2009. Combined with the relatively anemic new home sales level of about 500,000 homes, the total sales are about 6 million. In addition, refinance transactions have been brisk whenever rates drop below 5 percent, as has been the case through much of this 2009.

The Federal Reserve will fulfill its commitment at the end of the first Quarter of 2010. The question is: What happens then? Good question.

It has been widely discussed that some major banks are not holding mortgage-backed securities (MBSs), even for loans that they have originated. We know that the value of any fixed-rate security will decline if the interest rate increases and MBS are subject to that rule as well. When an investor does not want to own the security, the assumption is that he thinks prices will decline because market rates increase when the Fed stops buying MBSs.

Note also that the recently extended $8,000 homebuyer tax credit will continue until April 2010, so it will be expiring at about the same time, promising an interesting spring.

The good news is that there is A LOT of cash on the sideline. There are currently $3.5 trillion – yes, that’s trillion – in money market funds. I hope that with this cash and a renewed confidence in the housing market that the capital markets will be robust enough so that investors will jump in and start providing the same kind of liquidity that the Fed has been providing. If my hope is misplaced, we could easily see mortgage rates over 6 percent, not a good omen for a continued housing recovery.

If I were a potential homebuyer, I would be working very hard to buy my home before these forces collide. If you have a loan you want to refinance, I would do it now. We are seeing rates that are simply terrific. 30-year loans are below 5 percent and 15-year loans are below 4.5 percent. Why would you wait?