The Future of Mortgage Rates

03.16.10

For over a year now, the Federal Reserve system has been buying mortgage-backed securities from Fannie Mae and Freddie Mac. This has bolstered liquidity in those entities and, in the absence of private demand for such securities, has kept mortgage money flowing. It has almost certainly been a factor in keeping mortgage rates low and keeping the housing market on the road to recovery.

The Fed has always had a deadline of stopping those purchases at the end of the current quarter, on March 31st. The big question is whether the private sector is going to step up to the plate and start providing the funding, something like $1 trillion per year. Let’s be optimistic and assume so, but then the question is, “At what rate?”

Let’s see what the economists have to say. It is always interesting to look at those economic forecasts because they are all different. To me that means that one may be right and all the others wrong, or, more likely, all of them will be wrong, just in varying degrees.

A quick way to track mortgage rates is by charting the yield on the US 10-year Treasury Security, one that is highly correlated with mortgage rates. You can see that from the chart at the bottom of the page. As a jumping off point, the current yield is 3.6 percent and 30-year conforming loans are about 4.75 percent.

Morgan Stanley forecasts that the 10-year bond yield will go to 5.5 percent by the end of this year. That means mortgage rates over 7 percent and that would certainly squash the housing recovery. Refinances would come to a screeching halt.
 
Pimco, the giant bond management firm, has a different view. They think that the yield will be in the low 4 percent range. That correlates with mortgage rates in the low 6 percent range.

Goldman Sachs does not see the Federal Reserve raising short-term rates and projects that long-term rates will stay in the 3 percent range. That argues for mortgage rates to trade more or less in the same range that they have this year hovering around 5 percent.

That certainly gives you a large range to choose from and, to my mind, highlights the problems of seeing into the future. In fact, the interest rate picture is dependent upon many variables these days.

The most important is the speed with which the economy restores its health, particularly in the area of job creation. The future just does not look bright. Can you think what industries and services are going to add 10 million jobs? 

The continuing residential mortgage foreclosure problem isn’t going away. The fact that some lenders have actually stopped the foreclosure process and are letting delinquent borrowers stay in their homes does not solve the problem, just defers it. The real route to a solution is to reduce the principal balance owed, but lenders are still hesitant to do that.

A newer problem is now visible and is about to become the next crisis du jour. That problem is the coming wave of defaults in the commercial real estate market. Loans on office buildings and warehouses and the like are typically done with loan terms of 10 years, not 30 years as in the residential market. Many of these loans are coming due and there is no new source to provide financing to allow them to be paid off.

Obviously the existing lender, if it is a bank, can roll over the loan and write a new one, but they will then be criticized by their regulators. Many projects were financed through Wall Street with what are called conduit loans that were sold to investors as mortgage backed securities. There is no conduit market today and the buyers of those securities are hard to find, much less negotiate with.

So what does this mean for you?

I hope this has demonstrated how silly it is for you to try to figure out what rates are going to do and then base your decision on your guess. The most brilliant economists spend their careers trying to forecast rates but get it wrong so often as to make you wonder why they get paid the big bucks. So I have to say this bluntly: you are only an amateur and you will be wrong.

The world might get better, but it might get worse too. You don’t know which and you won’t have a better clue tomorrow. So the answer is this: if a transaction makes sense today, do it. That means is that if you want to buy a home and can afford it, do it. If you have a fixed rate loan higher than 6 percent, refinance it. If you have an ARM or a hybrid loan that is about to come to the end of its fixed period, you can benefit from refinancing, so do it. 

Just do it.