Interest rate mysteries
To some people, gambling is a harmless past-time; to others it's an addiction that can be costly and compulsive. But whether you consider yourself a gambler or not, just by virtue of the fact that you're part of the United States economy makes you a gambler by default.
The irony of what is going on with our economy is almost too much to take. The same day that Standard & Poor's downgraded the United States from an AAA rating to an AA+ rating was the same day that mortgage interest rates fell to an all time low. Two days later, Standard & Poor's also downgraded Fannie Mae and Freddie Mac. The irony of this is that one of the potential negative effects of these downgrades by S & P is the possibility of interest rates going up on everything including mortgage interest and origination fees.
When our treasury bills are downgraded the U.S. Treasury may have to offer them at a high rate of interest to make them more attractive around the world. Since mortgage interest rates typically track the yields on the 10-year treasury notes, a side effect could be higher rates on mortgage interest to borrowers in this country. Further, downgrading Fannie and Freddie's ratings could also increase their costs leading to higher mortgage rates.
The one bright side is that the Federal Reserve did surprisingly announce that it would not consider increasing the prime rate until 2013. This announcement will give some stability to the interest markets going forward, however, since mortgage interest tracks treasury notes it may not necessarily benefit mortgage rates.
Confused yet? Don't be; you're in good company. As of this writing, we don't yet know what the effects of this downgrade will be on interest rates, but I can tell you what the rates were on the day the downgrade was announced.
On Aug. 5, the mortgage rates had fallen to the lowest levels of the year. The average rate on a 30-year, fixed-rate mortgage fell to 4.39 percent, which was down from 4.55 percent the previous week and 5.05 percent from six months ago. Rates on 15-year, fixed-rate loans dropped to 3.54 percent, the lowest rate since Freddie Mac began its survey in 1991.
The reason for the decline in rates again goes back to the 10-year treasury note. Before the downgrade by S & P, the interest on treasury notes was falling because of investors moving funds out of the stock market and into what was then considered to be more stable treasury securities.
In spite of these lower rates, refinancing residential mortgages did not seem to be affected even though 42 percent of 30-year, fixed-rate mortgages could benefit. The likely reason for this is the lack of many homeowners to qualify for a refinance because of lost equity on their property, a loss of income or lower credit scores.
Although increased interest rates for home financing won't affect homeowners who currently have fixed rate mortgages, it could increase monthly payments for adjustable rates mortgages, not to mention new financing. For example, a rule of thumb holds that every one percentage point decline in rates effectively reduces home costs for buyers by roughly 10 percent. If mortgage rates raise by a percentage point the monthly payment on a $500,000 mortgage increases by $300 or $18,000 over five years. I almost hate to say what could happen to an already anemic housing market if interest rates go up by one percent.
We don't usually think of mortgage interest rates as a form of gambling, but make no mistake about it, because of the way the country's financial direction is going, pretty soon buying a loaf of bread could be a gamble. Does Washington have a gambling problem, you think?