Mortgage Blog

Okay - this is a long one: There is a lot to discuss regarding the lower rates – The first part of the blog is related to why rates are dropping and what is in store for us in the near future. The latter part of this blog offers advice on how to best take advantage of these historically low rates. Yes, there is some self promotion that is directly related to my business operations, after all arranging home loans is how I pay my bills.

So, here goes…………

The recent rate drop really got started when the Federal Reserve announced in early December that they were working on implementing a program to purchase Mortgage Backed Securities backed by FNMA and Freddie Mac. The actual Federal Reserve quote: “the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally”

What this means: The Fed wants to drive interest rates down to a level that will stimulate the housing market. By giving potential homebuyers an incentive, (low rates), to purchase existing homes at very low prices, this will create a “bottom” in our recent housing market decline. Lower interest rates will also allow homeowners to decrease their monthly mortgage expenses through refinancing. If a homeowner can save $200 to $300 on their mortgage payments, they will have extra money to put back into the economy.

How this works: This week the Federal Reserve became an investor in the home loan secondary market. They did this by purchasing Mortgage Backed Securities, (MBS), from banks and lenders. For example, the Fed purchased some of these packaged loans (MBS) which represent a 4.5%, 30 yr fixed mortgage. The bank or lender can now offer a 4.5%, 30 year fixed mortgage to a consumer and be able to sell that loan to the Fed. Once the loan is sold to the Fed, the bank has replaced their capital and can make another loan.

The bank can keep doing this because they receive a commission by the investor, (in this case the Fed), of 1% to 2% of the loan amount. In theory, the bank or lender should be able to offer the 4.5% loan to the borrower with no points being charged because they are already earning a commission. The reality is that banks and lenders have recently been charging points and/or extra fees to consumers for loans in this range

One of the reasons that the banks or lenders have not been willing to offer the no points loans at this level yet is because they have too much business to handle properly. They are overwhelmed by the recent volume of loan applications submitted to them. For the last 2-3 years, banks have been drastically cutting staff in loan operations because of their lack of revenue. They have essentially been working with skeleton crews. Last week I spoke with a lender who said they had just hired 20 underwriters; however, they did not have enough office space and computers available for them. Now they are scrambling to set up for this onslaught of business. One of the concerns in offering these rates with no points are they realize they would surely be even more overwhelmed.

Another reason is that most in the industry believe that interest rates have the potential to drop even further. All of the fundamentals are there: low or non-existing inflation, economic recession, falling gas & oil prices, etc… Let's say, for example, a bank or lender makes a loan to a consumer at 4.5% with no points. The bank then sells the loan to an investor at 4.5%; thus receiving the 1% to 2% commission. One month later, rates decrease to 3.75%. The same consumer decides to refinance again and pays off the 4.5% loan. The commission that the investor had previously paid to the bank has a time contingency attached to it. Meaning if that loan is paid off too soon, usually within 3-4 months, the bank may have to reimburse all or part of their commission to the investor. In order to keep this from happening, the bank assumes the borrower will be less willing to refinance again if they pay points and fees for the original loan. The bank would have the points and fees compensation to offset the money it would lose should the borrower refinance again.

Bottom line is: Once the banks get caught up and have sufficient staff to handle the expected business, rates should improve further. Once the banks believe that rates have hit a floor, we will see more loans with no points and/or no points, no fees.

The big unknown is how long this will last. If there is any hint of the economy improving in the next few months due to this program or stimulus, rates could increase quickly due to concerns of inflation. Remember, we have witnessed several rate drops over the years that have only lasted a few days before they have shot up again.

Of course, the best scenario is for a borrower to lock in their loan rate when it hits bottom. The problem is no one knows where that bottom is. Is it 4.5%? Is it 3.5%? Will it hit 2.5% on January 28th at 11:32 am? And if it does, will you be able to lock in that rate before it climbs to 5.5% by 11:55 am? Even the highest paid experts do not know where that low is, why should you or I pretend that we have a crystal ball?

My solution: Have someone, (a mortgage professional like myself), help you calculate payment and interest savings so that you can see if it makes sense to refinance or not. Look at a couple of target interest rates; if it makes sense to refinance at 4.75%, no points, make that your “trigger rate”. When and if rates decrease to 4.75%/no points, your mortgage professional would be ready to lock that rate in.

What, you ask, do you do if you've locked in at 4.75% and 2 weeks later the rates drop to 4.25%, no points? Well, several lenders now offer a “re-lock”. This means that if rates significantly drop they will allow you to obtain the lower rate. Now you don’t miss out on a lower rate. If the market gets worse and rates increase, you will still have a great rate of 4.75%.

Another possible scenario: You close your loan in February at 4.75%. Rates drop in April. Now several banks and lenders will offer a streamline refinance program that will allow you to refinance again, dropping your rate even further, with little or no cost.

While there is no perfect way to take advantage of this low rate environment, the above examples give you the best chance of improving your financial situation with the least amount of risk.

Last - We would like to offer our condolences to Bob Moore's family. He passed away last week at the age of 56. He was a fixture of our small community. He was well loved and will be missed.