Low mortgage rates "living on borrowed time," could climb next month

The best mortgage refinancing deals may soon be history.

"Low mortgage rates are already living on borrowed time," says Richard Barrington, a consultant for Moneyrates.com. "There absolutely should be a sense of urgency."

Inklings of an improving economy combined with the Federal Reserve's intention to wean us from government subsidies could nudge interest rates, which are currently under 5% for fixed-rate mortgage loans, upward. Current estimates call for a rate increase of somewhere between 0.5 and 1 percentage point as early as next month, with some economists projecting an even higher uptick.
Government Expected to Back Away

A key factor in the direction of interest rates is the anticipated March 31 end to a government initiative to buy mortgage-backed securities. Under the program, the Federal Reserve became virtually the sole investor in these securities, buying up more than $1 trillion. This has kept fixed-rate mortgages an estimated .75% below where they might have been.

When the government backs away, outside investors will need a financial incentive to pick up the slack.

"The idea is to get that (securities) market going again in 2010 and interest rates will need to rise to make that interesting to investors," says Bernard M. Markstein, senior economist with the National Association of Home Builders. However, Markstein adds, if rates rise more than a quarter point or so, "the Fed will be back in the market, limiting the rise."

Though the federal government has consistently signaled its desire to end the subsidy and did so again last week, Keith Gumbinger, vice president of financial publisher HSH Associates, says the March deadline is not hard and fast.

In economics, though, perception can become reality and some see signs that the market is already anticipating the government's withdrawal, meaning rates could rise even before the end of March. "The only thing keeping rates down now is negative news on employment and world financial markets," says Drew Sygit of The Lending Edge Team at First Michigan Bank.

In addition to the planned federal pullout, other factors that may boost mortgage rates include the large federal deficit and an end to other government-sponsored stimulus efforts, including the Home Buyer Tax Credit set to expire on April 1. Testifying before the House Financial Services Committee in early February, Federal Reserve Chairman Ben S. Bernanke said the Fed may raise the discount rate it charges on direct loans to commercial banks, now set at 0.5%.

Granted, higher interest rates linked to an improving economy are hardly a tragedy. "An environment that brings about lower rates is not filled with the things that you wish for: a stumble in the economy, a global event," says Greg McBride, senior financial analyst with Bankrate.com. "It's not the kind of stuff you want to be rooting for."

How High Will Rates Go?

Though a rate creep is widely expected, precisely how high lending rates will go this year remains a matter of debate.

"Before the feds started their buying spree, rates were around 6%," says Sygit. "I don't think we're going to hit 6% because of some other world financial factors at play, but I think we're going to see an uptick to the mid-5s, even the high-5s. And right after that, the road is unclear because we're in uncharted territory with the national economy."

Barrington has run his own numbers based on the historic difference between inflation rates and mortgage rates. Over the past two decades, the cushion for investors has been about 4.5%. Currently, since the main investor is the federal government, the spread has fallen to about 2%. Just adding the norm to the current rate of inflation would bloat mortgage rates to at least 7.3%.

"I don't think they will go that high; things don't normally work in lockstep with their historic norms," Barrington says. "But those figures tell you just how far outside of normal the current situation is."

Yet, even just a one percentage point increase can result in a substantial increase in one's mortgage payment. "I am educating clients on the rate movement and how 5% to 6% is a 20% increase in payment," says Minnesota broker Jay Dacey. "Coupled with FHA funding fees going from 1.75% to 2.25% after April 5, a lot of 'fence sitters' are taking action."

The Mortgage Bankers Association reported earlier this month that refinancing activity was up slightly in the early weeks of 2010 and made up a larger share of total loan applications -- nearly 70%. Ric Dizon, a senior loan officer with Prospect Mortgage in Southern California, says he has seen that trend in his own business and expects traffic to increase as knowledge about the potential uptick spreads and tax season hits high gear.

Homeowners Should Start the Refinancing Process Now

Though the phase-out of government subsidies is a reflection of increasing confidence in the economy, it is possible the action could stall the nascent recovery.

The private market might not be able to pick up the slack once the government pulls out, causing interest rates to rise and refinancing demand to fall -- and along with it, the demand for mortgage securities backing, says Gumbinger. The private market would then be able to handle that diminished flow, causing rates to slip back down.

Because of such uncertainties, brokers are recommending people begin the refinancing process now, then lock in when they hit their desired rate, especially since last minute over-the-phone qualifications are precluded by today's tighter lender restrictions.

"Lock as soon as your target rate is available," says Denver broker Todd Huettner. "Waiting for lower rates is the biggest mistake people make when refinancing.
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