Mortgage Rates

So what in the world is going on with mortgage rates? We have so much volatility its hard to judge the direction. Keep in mind the market is highly emotional right now. From day to day you don't know what is going to happen.

I try to coach my buyers the best I can but sometimes the window of opportunity is only there for a couple of days and then gone again for a few weeks.

Many people do not realize that mortgage rates are determined by the secondary market for mortgage-backed securities. Let me explain what I mean and it will make more sense.

Lenders make loans to borrowers for mortgages, car loans, etc. Lenders can get their money from a few places. Deposits are the cheapest. This is why banks REALLY stress and focus on what is called core deposit growth.

Banks can also use short term funding like commercial paper or short term notes usually ranging from 90-120 days. They can also borrower from other banks. If the lender is publicly traded they can raise capital through the issuance of more shares or preferred shares. Preferred shares are a hybrid of stock and debt and are paid dividends by either a percentage or dollar amount per share. Example 8% preferred would pay 8% interest on the par value of shares held. If the pare value is $100, they would receive $8 dollars a share. If the stock is a $3 preferred, this would mean that the investor would get $3 per share regardless of the par value (example if the par value was $60). Issuing common shares would dilute common shareholder equity and is usually not seen favorably by investors with big positions within the company. This is a whole other topic.

So once the lender makes the loan they can either hold the loan on the books, a portfolio loan, sell the note to an investor such as Freddie or Fannie -- these are government sponsored entities with the sole purpose of providing liquidity in the mortgage market -- or they they can sell the note and then sell the servicing rights altogether. Selling the note and servicing provides fee income for the originator of the loan and then frees up the capital to go lend more moving all the risk to someone else.

Freddie Mac and Fannie Mae will then pool these loans together and package them into securities and sell them as bonds to investors worldwide. This is also to provide more liquidity to them so they can continue to buy more and more loans. The cycle just repeats itself.

Freddie and Fannie do have loan limits that are set by the Federal Housing Finance Agency, who on July 30 2008 was created by the Housing Recovery Act, to oversee Freddie, Freddie, and the Federal Home Loan Banks, to make sure the secondary market is functioning properly.

These MBS or Mortgage-Backed Securities are sold in the form of bonds. If you are not sure with how bond pricing works it can be a little confusing. When bond prices move up (which means investors are buying), the yield at which those bonds pay goes DOWN. Yes that's right price and yield move inversely from each other. When bond prices move down (which means investors are selling), the yield moves up. This can get really complicated because a bond has a stated interest rate or coupon, doesn't mean the investor will pay that. Market prices change all the time and if an investor wants a higher yield, that means the price has to come down.

So what does all this mean? Well it means that if the yields go up on the bonds, mortgage rates will follow the upward trend. This is because mortgages have a risk of prepayment either through selling the home or refinancing into a new loan. When this happens investors do not get the cash flow from the bond they anticipated so to compensate for that risk these bonds are traded at a spread of government bonds. Spread simply means a numeric figure, expressed in terms of basis points, over the index (the government bonds). Basis points are a fraction of percentages expressed as a unit of 100. Example 1 basis point is 1/100 of a percent. One hundred basis points would be equivalent to 1%.

Right now investors are skeptical of the condition of the economy and even though the government is pumping billions of dollars into the system it boils down to investors wanting higher returns for loaning their money. Bottom line don't play the guessing game. If you are in the market to purchase a home now is the best time to do so.

Why you ask? Even though we have price volatility, mortgage rates are still at historical lows and on top of that you have home prices that have fallen some 30% in some areas making more homes affordable. Don't waste time we will start to see home prices going back up soon so don't get left holding the bag trying to wait it out to the last minute and time the market.

As a warning please make sure you work the numbers of purchasing a home prior to making any offer. Speak with a professional, sit down and work out your budget. Make sure you can afford to make the payments and don't get caught in the trap many Americans did by splitting hairs just to buy a home. Homeownership is the American dream.

Thanks

Dustin

Copyright © 2008 by Dustin Swigart