Rate Outlook

Last week's drop in mortgage rates was a welcome relief, and you would think that more relief should be forthcoming. After all, inflation appears to be a dead issue, given recent data on producer and consumer prices. Inflation and interest rates are highly correlated: When one falls, the other usually falls in tandem.

But there is more to the story than inflation. All interest rates are determined relative to risk-free market interest rates, with short-term Treasury bills serving as a proxy. But most interest rates are not risk-free. Mortgages rates are certainly not risk-free, which is why they are higher than Treasury bill rates. What's more, mortgage rates are heavily influenced by rates on mortgage-backed securities (MBS). MBS rates, in turn, are heavily influenced by yields on Treasury bills, notes, and bonds.

And there is the rub. Treasury securities prices tumbled last week after the government announced $104 billion in debt auctions. As rates on Treasury securities increase to attract buyers, there is a crowding out effect, because Treasuries compete with other debt instruments for buyers. If Treasury securities must raise their yields to attract buyers (which happened last week), then so do most other debt securities; hence, a possible increase in mortgage rates.

We can't be sure what impact this crowding effect will have. Rates could go higher, but they could go lower too, particularly if the Federal Reserve continues to implement its $300-billion program to create demand and keep a lid on rising rates. But why chance it? Thirty-year fixed-rate loans averaging between 5.5% to 5.75% are still a very good deal, as are the deals found on most existing and new homes on the market.

Eric P. Egeland
Broker Associate
RE/MAX UNITED
847.337.7090
DeerfieldsAgent.com

Rate Recap

Interest rates across the board spiked last week. Depending on who you asked and when, the 30-year fixed-rate mortgage rose as much as one percentage point. Officially, Bankrate.com has the national average at around 5.5%, but its survey was conducted before the full brunt of the increase.

Various explanations were given for the spike in interest rates. Impending inflation was at the forefront, with one particularly animated pundit claiming U.S. inflation could approach Zimbabwe levels. Fact is, most people are already expecting some inflation down the road, so inflation alone was an unlikely reason. A more plausible explanation is that the Treasury Department has been issuing so much debt lately, $101 billion worth last week alone, that it simply swamped demand, so bond prices fell and the interest the Treasury had to pay to attract buyers rose.

At any rate, it's not the end of the world. Over the past 25 years, the 30-year fixed-rate mortgage has averaged around 7.8%. In 2007, the average rate was around 6.3%. And even last year, the average rate was around 6.2%.

The big concern with last week's rate spike is that it could put downward pressure on home prices and sales. It's a legitimate concern, to be sure, given that existing home sales rose again in April to an annual pace of 4.68 million units, with about 45% of April's sales attributable to foreclosures and short sales. Meanwhile, new home sales continue to make positive strides, albeit slight, with sales rising to 352,000 units annually.

The good new is that homes remain affordable, at least when vetting the national numbers, which, admittedly, aren't always applicable to the local scene. That said, the median price for an existing home in April was $170,200, while the median price for a new home was $209,700.

Eric P. Egeland
RE/MAX UNITED
847.337.7090
DeerfieldsAgent.com

Market Recap

If a retailer wants to stimulate sales, what does he do? He lowers prices. It's a simple, yet powerful, principle of economics that we've been proselytizing over the past two months, and for good reason, it works. To wit: The National Association of Realtors (NAR) reported that its index of pending home sales, which measures contracts signed but not closed, rose 6.3% to 87.7 in December. Year-over-year, the pending-home-sales index was up 17.5% in the West and 1.6% in the South. Even more encouraging, the index's numbers reflect the most favorable combination of home prices, mortgage interest rates, and family income since tracking started in 1970.

Lower mortgage prices have contributed greatly to improving housing affordability. The prime 30-year fixed-rated mortgage has been floating below 6% for the past three months. But the mortgage market's contribution could diminish in the near term. Recent news that the federal government is seeking ways to lower mortgage-rates further sounds like a positive, but could actually be doing more harm than good. Yes, lower rates are a good thing (and we understand the NAR supports intervention to push rates lower), but if people are always anticipating lower rates, they hesitate to act today. Let's not forget that mortgage rates in the 5% range are darn-good rates, and even those can be readily refinanced if the feds succeed in pushing rates down.

While housing prices and mortgages have trended lower, unemployment has trended higher. Jobs, or the lack thereof, is the monkey wrench that could conceivably grind the housing-recovery gears to a halt (operative word being “conceivably”). On that front, there was much media teeth-gnashing and lamenting last week because the unemployment rate rose to 7.6% on 598,000 lost jobs in January.

How did the financial markets react to the “dire” unemployment news? The Dow Jones Industrial Average surged ahead 150 points in the first hour of trading. Like we stated last week, many economists view the recent job cuts as a bottoming of the recession, not an omen of things to come. It appears the stock market shares the same view.

Eric P. Egeland
RE/MAX UNITED
847.337.7090
DeerfieldsAgent.com

Housing Recap

Yesterday’s housing bill is today’s housing law. Among the highlights, first-time home buyers will receive a tax credit of 10% of the purchase price of their home, up to $7,500. If you are wondering how Congress defines a first-time home buyer, it’s someone who hasn’t owned a house in the past three years. The validity and efficacy of the credit has to be questioned, because it’s really not a credit; it must be repaid in equal installments over the subsequent 15 years.

Another highlight helps people who have fallen behind on their mortgages and who owe more than their houses are worth. In such situations, refinancing is difficult, if not impossible. The law seeks to resolve this dilemma by encouraging lenders to forgive delinquent borrowers’ debt down to 87% of the property’s current appraised value. At that point the homeowner can than refinance under an FHA plan (though he or she will be expected to pay higher FHA insurance premiums).

The new law imposes few changes on Fannie Mae and Freddie Mac. Both institutions are a mess, yet the law oddly imposes no changes in management or business approach and no penalties on shareholders. Taxpayers instead are given two dubious protections: The first is that the treasury secretary will have the right to dictate terms if the government has to stump up equity capital for the firms. The second is the creation of a new regulator, whose effectiveness one must question, considering the effectiveness of past regulators.

Outside of the housing market, general economic health is waning. U.S. second-quarter gross domestic product came in below expectations, rising 1.9% versus expectations for a 2.2% rise. Slowing GDP, in turn, is impacting employment, and not in a good way. On Friday, the employment situation showed that payrolls declined by 51,000, pushing the unemployment rate up to 5.7%.

Eric P. Egeland
RE/MAX United
847.337.7090
DeerfieldsAgent.com

Housing Bill

We saw a lot of coverage to last week’s House vote to offer $300 billion in assistance to troubled homeowners and to throw government support behind Fannie Mae and Freddie Mac. The bill has won endorsements from key senators in both parties and convinced President Bush to withdraw his long-standing veto threat.

Major provisions of the bill for mortgage markets include permanently increasing the cap on the size of mortgages guaranteed by Fannie Mae and Freddie Mac to a maximum of $625,000 from $417,000. It would also raise the FHA maximum loan limits for high-cost areas to $625,000. For first-time home buyers, the bill includes a tax refund worth up to 10% of a home’s purchase price but no more than $7,500. That said, the refund really isn’t a refund – it’s more of an interest-free loan, because the “refund” has to be repaid over 15 years in equal installments.

The bill will likely give the mortgage and housing markets an immediate boost, but let’s not get carried away with the back-slapping. Artificial stimulus packages are fickle; you can’t be assured that what you want stimulated is actually being stimulated. Besides, markets, if left to their own devices, eventually get it right, though sometimes not as quickly as we’d like. But when they do get it right, they tend to get it right on a more permanent footing.

Eric P. Egeland
RE/MAX UNITED
847.337.7090
DeerfieldsAgent.com