Nothing Lasts Forever
We have heard it before and still we hate to see when it
happens again. So goes the historically
low interest rates that have spurred the housing market for the last year.
Since the early summer of 2012, interest rates for a 30 year
fixed rate mortgage have hovered in the mid 3% range. Over the last 2 weeks, they have soared to
over 4% and the long term perspective is that they will go higher. Why?
Nothing lasts forever.
I have had several clients on the fence about either locking
an interest rate for a purchase loan or pulling the trigger on a
refinance. We were all losers last week
because of the volatility in the market.
I have explained the reasons to several clients and co-workers and will
share this with you as well.
The biggest reason rates are going up is that no one in the
financial markets is making any money with the 30 year rate at 3.5%. The bond market works like this:
1.
The Borrower takes out a 30 year fixed rate loan
with the local mortgage company.
2.
The mortgage company then sells the obligation
to one of the large mortgage Guaranteeors- Fannie Mae, Freddie Mac, VA, FHA or
USDA. We call these GSEs.
3.
The
mortgage company retains the servicing rights and collects the monthly payments
from the Borrower. We thus call the
mortgage company the Servicer
4.
The GSEs puts all of the mortgages they have
bought together in a pool and securitizes them- meaning they sell large blocks
of these Mortgage Backed Securities to Investors on the open market. The Investors are large investment companies,
insurance companies, governments, retirement funds, etc., who buy these
securities because they are safe investments.
5.
Every month the Borrower makes their payment to
the Servicer, who takes out a small percentage of the interest as a fee and
then forwards on the rest of the interest to the GSE. The GSE also takes a percentage of the
interest. The remaining interest is paid
out to the Investors who own pieces of the mortgage backed securities.
Here is an example of how it works (not exact but close): Let’s say the interest rate is 3.5%. Every month the borrower pays that interest
to the Servicer, who takes out 1% for their costs. The remaining 2.5% is forwarded on to FNMA
(the GSE) who also takes 1% for their costs.
That means they are forwarding on 1.5% to the Mortgage Backed Security
bond holders or Investors.
That means if you have a $100 million dollars to invest, you
are only earning 1.5% on your investment.
The inflation rate in February 2013 was 1.98%. That means that every month you are losing
money when adjusted for inflation.
Why would anyone invest at those rates? -Because they have to put the money
somewhere.
When the economy is good, these organizations invest their
money in the stock market, where they can make larger returns. When the economy is bad, they put their money
into bonds where the investment is safe.
Over the last year, our economy has been struggling. There has been uncertainty about unemployment
here in the U.S., coupled with the uncertainty concerning the European Union
and what impact their economy would have on the global markets. For all of these reasons, the Federal Reserve
has been buying up Mortgage Backed Securities, as part of QE3, to artificially
lower mortgage rates and thus stimulate the housing sector. Their belief is that an active housing sector
will boost the economy. I.E.: If you refinance to a lower rate, you will
spend the savings on other stuff (cars, toasters, trips, etc.). If you buy a house because rates are low, the
realtor, title company and lender will all make money which will be spent in
the economy. Also, home buyers do things
like, buy furniture, hire movers, painters, landscapers, buy insurance, etc…all
of this stimulating the economy.
Sounds like a good idea, but the government can’t afford to
do this forever. Over the last month the
economic news has become better.
Unemployment numbers are down, Europe is stabilizing, housing numbers
are up, consumer sentiment is up, etc.
All of this has led to a more robust stock market. When the stock market is strong that is where
you will make the largest returns on your investment.
With a stronger economy and stronger stock market, Investors
are pulling their money out of bonds and putting it in stocks. The Fed has said they are going to pull back
and eventually quit buying Mortgage Backed Securities. All of this lessens the demand for
bonds. When no one wants to buy bonds,
the GSEs have to offer a higher return on the investment- I.E. They have to raise
interest rates to stimulate demand, which is exactly what is happening now.
Nothing lasts forever.
Mortgage rates have been artificially lowered over the last 4 years due
to the economy and government intervention.
The economy is improving and the government is stopping their
intervention. Rates have to go up and
will. No one is making money with a 3.5%,
30 year fixed rate.
For the short term, you should remember that nothing goes
straight up or straight down, so there will be some small intervals with
improving rates. But overall interest
rates are on the way up. I think we will
see rates in the 4.5%- 5.0% range by the end of the year.
So, for your clients, I recommend locking for the long
term. 4.0% or 4.25% is going to look really
good by the end of the year.
Whether you are a Borrower hearing the chorus of “The
Parties Over” or an Investor hearing “Mo’Money, Mo’ Money!” Remember, nothing lasts forever.
**Author's Note: I have been and frequently am wrong about which way interest rates will move. When I become good at predicting rates, I ill get out of the Mortgage Market and into the Bond Market were I will make a fortune- Analysis is based on experience but does not guaranty future performance.
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