Mortgage Rates — Important Information
Where are mortgage rates headed? The short answer is that no one knows for sure. With that in mind there are ways to analyze trends and make a best guesstimate. This discussion will focus on how the process works, the influence of the Federal Reserve and outside influences that affect mortgage rates.
How the process works
There are three levels of transactions that bear upon the rate. First we have the originator of the mortgage. They write the mortgage paper. However they do not hold it. They sell it to a middle- man called the aggregator. The originator must know at what rate the aggregator will buy the loan. He must make a profit so he will mark up the rate as his profit.
The aggregator also does not hold the loan. He buys several mortgages and packages them into a Mortgage Backed Security (MBS.) The process is called securitization. MBSs are then sold to investors who may be mutual funds, banks, hedge funds, foreign governments, insurance companies or Fannie Mae and Freddie Mac. Here too, the aggregator must know at what price he can sell the MBSs. He too, has to take a mark up. So the rate that a person pays at origination is dependent upon the rates at each level in the process.
The type of mortgage a person chooses will also affect the rate. A 30 year fixed rate mortgage will carry a higher rate than a shorter- term adjustable loan. The general rule is that the longer the term, the higher the risk and hence the higher the rate. An adjustable rate mortgage is quite different. The rate is based on two factors. They are an index that is circulated among professionals and a margin that is tacked on to the index.
The margin stays fixed while the index fluctuates with mortgage rates in general. The rate can be adjustable every month, every six months or annually. Because the index follows the change in rates closely, the rate is usually lower due to less risk.
The influence of the Federal Reserve
The Federal Reserve plays a key role in setting mortgage rates by their actions in the open market. First they set the Fed Funds rate or very short tem rates. The latest minutes of The Federal Reserve Open Market Committee (FOMC) set the range for the Fed Funds rate at 0 to ¼ % until 2013. Their reasoning was that the economy is still weak and unemployment is too high. The Fed then issues notes and bonds with varying maturities, including 5 and 10- year notes. Remember the index for adjustable rate mortgages. It is based on the interest rate for the US 10 year note. So the Fed has a hand in directly influencing mortgage rates.
During the financial crisis of 2008-2009 the Fed stepped in and bought a whopping $1.25 trillion of MBSs in the open market. After two more bouts of quantitative easing (QE 1 and 2) The Fed is using the proceeds from its transactions to continue buying MBSs. The latest Fed policy is called Operation Twist. They are selling short term notes less than five years and buying notes 6 years or longer to push interest rates lower.
As mentioned above economic conditions in the country affect interest and mortgage rates. Presently our economy is struggling with high unemployment. Businesses are sitting on huge piles of cash but are unwilling to circulate the money in the economy. This adds to the problem. Our deficit reached $15 trillion. This is putting pressure on the Fed. It pretty much rules out further easing, at least for the time being.
Europe is in deep financial crisis. Investors are fleeing euro bonds and buying US Treasuries. While European rates are high, the influx of capital into US bonds and notes is keeping our rates low.
To summarize, the Federal Reserve is committed to keeping interest rates low into 2013. However, if the economy improves substantially or if unemployment drops, all bets are off. The Fed may be forced to raise rates sooner than anticipated. This, in turn, will drive mortgage rates higher.