Mortgage Q&A: Poor loans play tag with rates

By Henry Savage SPECIAL TO THE WASHINGTON TIMES | Friday, November 7, 2008

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Federal Reserve Chairman Ben Bernanke and his colleagues unanimously agreed to lower short-term interest rates last week. Specifically, they agreed to lower the federal-funds rate to 1 percent. This is the rate that banks charge each other for overnight funds.

Unfortunately, contrary to what many would think, mortgage rates shot up on the news. Mortgage rates usually follow the Fed's actions over time, but, indeed, they are more influenced by market forces. The ongoing credit crunch and continuing lack of demand for mortgage-backed securities is keeping mortgage money expensive.

The text of the Fed's statement was particularly gloomy, predicting a drop in consumer spending and continuing difficulties for consumers and businesses to obtain credit. The Fed also indicated that inflation is no longer a major concern.

In fact, after poking around the Internet, I found that many economists are beginning to suggest that deflation will be the next big threat, which is a sharp fall in prices.

As a mortgage professional, it's been pretty frustrating during the last couple of years to watch interest rates across the board fall, with the exception of mortgage rates. The yield on the 10-year Treasury bond, once used as a good barometer of the direction of mortgage rates, has remained under 4 percent for most of this year. The last time the Treasury bond's yield was this low for a prolonged period was 2003. Back then, I was quoting a 30-year fixed-rate mortgage in the low 5 percent range with no points.

In 2008, with the 10-year Treasury bond again under 4 percent, I'm quoting 30-year fixed rates in the low 6 percent range. While these rates might be considered low compared to the late '70s and early '80s, they simply aren't low enough to jump-start the housing market or stimulate the economy by providing a refinance market.

Why is the spread between Treasury bonds and mortgage rates so much wider than it was in 2003? The answer is easy: The subprime meltdown and subsequent spillover into the conventional mortgage arena, coupled with falling home values, steered investors away from mortgage-backed securities, which were once considered a high-yielding and safe investment.

I still contend that the spread should narrow and mortgage rates should fall. Consider the following:

-- As part of the "rescue" plan, the U.S. Treasury announced that it is prepared to purchase underperforming loans from banks and the two mortgage giants, Fannie Mae and Freddie Mac. This will eliminate these underperforming assets from their books and free up liquidity to make new loans.

-- The days of "easy mortgage money" are over. Virtually all new loans originated nowadays require good credit, verifiable income and reasonable home equity.

Ultimately, investors in mortgage-backed securities will see that these assets are once again safe and lucrative, creating demand and lowering rates.

When will this kick in? That's the question. Stay tuned. I'm watching it like a hawk.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at henrysavage@pmcmortgage.com.

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