I'm sure all of you have been seeing the news of how bleek the economy is. To me its blah, blah, blah, blah. But now the Treasury is stepping up to the plate in an effort to reduce mortgage rates to the point that people jump into the market and start buying or refinancing. This is going to pull the first time homebuyers back in and start getting some inventory off the market.
The Treasury announced a purchase plan of roughly 600 Billion dollars that they will use to buy mortgage-backed securities and government issued treasuries over the next couple of months. So what does this mean? How long will this last? I'm not sure but for those of you who don't know why this makes rates go down I'll explain briefly.
Mortgage rates are tied to mortgage-backed securities. These are bonds that are issued by Fannie and Freddie which contain securitized mortgage loans. Pools of loans are put together then packaged into securities and sold as bonds. Now there are three areas of risk with these, credit risk (default risk), IR (interest rate exposure), and early redemption (pre-payment). Now as rates go down, pre-payment is more likely because people can refinance into a lower rate. When pricing these bonds for sale we must take into consideration bond convexity. Bond convexity is simply the measure of sensitivity to the duration of a bond to changes in interest rates. So what does this mean? Well it means that to compensate the risk of payoff to investors these bonds are priced at a spread (fixed margin) over government treasuries, usually the 10yr bond.
So in order for the purchase of mortgage-backed securities to work effectively the Treasury will also buy government bonds to drive down their yields resulting in lower spreads, thus resulting in lower mortgage rates. They are hitting this thing from both sides
By purchasing both government and mortgage-backed bonds, the Treasury is essentially subsidizing mortgage rates. As they buy up these bonds, prices go higher resulting in lower yeilds. Lower yeilds mean lower mortgage rates. I can tell you its worked. I've taken eight loan applications over the last two days and I expect it to get better after Thanksgiving.
Keep in mind, when first time homebuyers are not buying homes this leaves the market flooded with inventory. The sellers of this inventory can't buy another home until they sell theirs and so on and so forth. So see the first time homebuyer is essential and will cause a domino effect once they've returned to the market.
Now not all first time homebuyers have vanished but most of them are on the sidelines not sure what to do. I can't stress enough that this is a cycle that we will come out of eventually. The government is doing what they can to stimulate the market and we should see housing begin to stabilize when inventory begins to come back down to healthy levels.
The trends, in some areas, are starting to show positive signs of improvement. The one thing the media leaves out is that there ARE STILL loan options out there and banks are lending. The media makes its sound as if financing has all but vanished. This is simply not true. If you are in the market NOW is the time to jump. Don't wait for it pass by. There has only been a handful of days in four decades where rates have been lower. Rates have dropped about a full point in the last two days. This doesn't mean they will stay down so make a move if you're on the fence.
Realtors start picking up the phones.
Happy Thanksgiving!
Copyright © 2008 by Dustin Swigart
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