Mortgage Rates: Stimulus to Hold Them Low

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Interest rates can't stay low forever -- but mortgage watchers now expect rates under 5 percent for the next year, thanks in part to "quantitative easing," the latest scheme from the Federal Reserve to stimulate the economy.

The average rate on a 30-year, fixed-rate mortgage was just 4.23 percent with a 0.8 percent origination fee, according to the latest Primary Mortgage Market Survey from Freddie Mac. That's just a hair above the record low set a few weeks ago.

"I think rates are going to do about what they are doing now," said Amy Crews Cutts, Freddie Mac's deputy chief economist.

The latest stimulus

So what is quantitative easing? It basically means "printing money." The Federal Reserve is planning to create $600 billion in new dollars that it will release into the economy by buying up Treasury bonds.

The goal is to pump new dollars into the economy and fight falling prices.

The economy is now dangerously close to price deflation -- the overall rate of inflation is close to zero. Deflation could create a cycle of falling prices, falling wages and even more job losses. Japan suffered through a deflationary cycle like this in the 1990s. It lasted more than 10 years.

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For another example of the danger of deflation, look at housing. Falling home prices have created chaos in many housing markets. To keep deflation from poisoning the rest of the economy, the federal government is trying to raise the annual rate of inflation to its target of 2 percent.

"When the government prints money, inflation will follow," said Cutts.


What could go wrong?

Printing money brings to mind memories of governments on the brink of collapse and hyperinflation, like Germany in the 1920s. But federal officials say if the goal is to prevent the U.S. dollar from getting too strong in comparison to the price of goods and services, then printing money to purposefully weaken the dollar is one of very few reasonable choices.

Some economists also worry about other unintended negative consequences -- or no consequences at all. For example, investors might take the Fed's newly minted dollars and send them oversees, to markets with higher interest rates and investor yields, diluting the impact of the program and creating new bubbles in those economies. Emerging market countries could also retaliate with trade sanctions against a weaker American dollar that is less able to buy their cheap foreign goods. China, in particular, remains difficult to predict.

The Fed's quantitative easing program could also be too small to shift the U.S. economy decisively back toward growth. After all, the Fed already tried something like this during the financial crisis. They created $1.7 trillion and used it to buy bonds, mostly mortgage-backed securities issued by Fannie Mae and Freddie Mac. The purchases stabilized the price of the mortgage bonds, but the overall economy remains stubbornly weak. We were spared from deflation, but neither was there an economic recovery with real job growth.


Low interest rates through quantitative easing

Quantitative easing should help keep interest rates low -- though in the short term, interest rates are as likely to twitch upward as they are to twitch down -- and rates are unlikely to fall significantly lower, said Cutts. Freddie Mac predicted, in its latest October Outlook, that average rates will stay well below 5 percent for the next 12 months, though its forecast was issued before the Fed announcement. "Will interest rates drop below 4 percent? That's unlikely," said Cutts.

That's because the ingredients that make up mortgage interest rates are now about as low as they are ever likely to get. The yield on 10-year Treasuries was about 2.5 percent as of Nov. 4, close to its lowest rate in four decades. The yield on mortgage bonds is not much higher. Bank and servicer fees are also relatively low compared to what banks charged during the crisis.

Cutts herself recently locked in an interest rate on the refinancing of her own mortgage, rather than gamble on rates falling again. "Don't be greedy," she advises mortgage borrowers. "Don't worry about playing the market."

For more insight on mortgages and refinancing see these
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