COST AND RATE SHOPPING…

This is very important but I would like to present the reality of what a 1/8^th of one percent in the interest rate and/or $600 in closing cost really are.  I use these amounts because it’s over this kind of difference that I see some jump ship from one lender to another.  Now I’m Dutch, and I like saving money.  So hear me when I tell you that it’s not wrong to shop around and make sure you’re getting a good deal.  Just make sure you understand what the numbers are really worth.

Anyone who says they think they know for sure what will happen tomorrow (about rates or anything else) is at best naïve and potentially lying. This may be you, this may be your loan officer.  Either way, if you’re looking at a great deal but holding out for another 1/8% or a few hundred dollars, think about whether that’s worth the risk.

Remember, this deal could be over at any moment.

China could start lending money to India instead of buying OUR bonds. Our rates rise at even the thought of this happening.  Earlier this year, China’s financial leaders threatened it and our rates went up ¼% – and they never even stopped buying.

Corporations could start investing their cash again rather than parking it in Mortgage Bonds for security.  This would help unemployment and your stock balances, and I for one would welcome it, but it would bring the price of bonds down and rates would rise.

The US government could change its stance on printing money and buying bonds due to political pressure. I’m all for this one too.  But again, it’s another cause for the 60-year low in interest rates.

If any ONE of the above happened, rates would rise to some extent. If two or three of them happened at once, rates would rise quickly, and if you’re not locked, you’ll feel a pain in your gut like someone just erased $165,000 from your bank account.

One of my recent posts described how one of my clients erased all of his past real estate loss by saving $165,000 in interest by refinancing with us. What I did not go into in that post was how much more he could have saved, had he held out for an 1/8^th better rate.  He could have saved $3500 more.  wow.  That’s not a lot.

My point isn’t that $3500 is not a lot of money.  My point is that $165,000 is too much to risk for the benefit of getting $3500 more by waiting for rates to go down just a little more or by signing on with an unknown source.

Here are a few questions to help you say yes to the LO you are working with right now:

1. Do you trust him or her?  Will he or she make sure that the deal they promise you up front is the deal you get?
2. Is the deal competitive?  By that I mean is it at market rates and prices?  Anything within 1/8% in rate or $500 or so in cost of the competition is fair. It also helps if you can float down between the time you commit and the time you close. This isn’t the most important thing, but it could be nice if rates really improve after you’ve locked in. Most lenders offer this.
3. Did the LO help you understand your situation and see exactly what the benefits are compared to the cost? Did you learn something? Are the benefits good enough to make sense for you?
4. Does this person have time to process your loan right now?

If you have to say no to any one of these questions, then walk away and keep looking.  But if you CAN answer yes to all of them, you should make a commitment, stop looking around, and take the market gains that are present today.

They could be gone an hour from now.

Let’s look at recent proof for this reality.

Home buyers who accepted a deal by April 30th had 60 days to close their deals by June 30th to qualify them for the home-buyer stimulus credit. If deals can be closed in three to four weeks, then why did Congress extend the home-buyer-credit closing date past the 60th day? There are a number of factors that made it necessary…

~More offers on homes were written and accepted the week of April 30th than maybe any time in the history of selling real estate. Homes are moving faster even today than they were last year. Homes are a great deal, more people are buying. Which means the pipeline got full and slow very quickly.

~Then, in June, interest rates moved down one more notch to a level that is lower that at any time in relevant history. Even though home values are lower, this caused more loan applications to be submitted by loan officers for their clients than has recently been seen.  Both purchase loans and re-finance applications accounted for the increase.

~Remember too, that there are fewer lending institutions and conduits today than there were three years ago. So in an overall sense, the pipeline is narrower.

~Lenders are making the approval process more difficult by asking for more documentation.  This holds up the process of obtaining an approval and getting your deal to the closing table.

~Banks are the sellers (or in charge of short sales) in likely half of today’s purchase transactions. These banks contribute to slow closings because they have departments and hoops that need to be jumped through before deals can close.

~The above is not an exhaustive list.  If your deal was held up, leave a comment and tell us why. The stories are varied and weird.

Add it all up and, simply speaking, you have more files and a slower process. What was thought to be enough time to get deals closed, turned out not to be for hundreds of thousands of homebuyers – homebuyers who had their accepted offer completed by April 30.

So, you negotiated your deal on April 30 and paid a price that was likely inflated a little because you were convinced you would get the tax credit. Then for reasons (above) that were beyond your control, you did not close by June 30th.

Politicians would not have been able to live that one down. They voted to extend the closing date. This allowed those who made the purchase assuming they would get the credit to actually get it. The credit itself was not extended it was just given a little more integrity.

Closing in one or two months is most often do-able, but in today’s market, as we saw by the necessity of the extension, it’s just not always enough time.

Today’s post is all about giving FHA the love it deserves.

So. . . let my LOAN open the door . . .

Despite the rise in FHA’s up front insurance cost to 2.25% of the loan amount – FHA loans continue to gain market share as the most popular loan for home buyers – and not just first timers either.

The two big drawbacks of FHA loans are the monthly mortgage insurance (most FHA loans but not all) as well as the up front mortgage insurance premiums.

That means you will “owe” more than your sale price minus your down payment because of the Up Front Mortgage Insurance Premium which is not charged on Fannie Mae and Freddie Mac insured mortgages. You will also pay around $45 per month for every $100,000 you borrow.

Fewer and fewer home buyers are deterred by these in today’s market. There are at least 10 reasons for this:

1. First time buyers who have not been able to save a full 10 or 20 percent down payment are able to get in for just 3.5% down.
2. Move up buyers who sold their home for less net cash to them are still able to be buyers and buy a home from this market because of the low down payment.
3. The monthly FHA mortgage insurance can be dropped in as soon as 5 years.
4. On 15 year FHA fixed term loans with 10% down – there is NO monthly Mortgage Insurance.
5. 6% seller concessions allow for total money invested to be 3.5% of the sale price in most cases.
6. No interest rate add ons for 640 or above credit scores.
7. FHA Interest rates are as good if not better than conventional loan rates – with no points as of this writing they are at or better than 5%.
8. Underwriting is easier than with a conventional PMI loan and believe it or not, the appraisal process is faster and gives fewer hassles.
9. You can buy a home almost anywhere and at any income level. Even though in most markets the maximum loan amount is just over $270,000 – this is not prohibitive for most (95%?) qualified home buyers.
10. Even refinancing is easier. Those in a non-traditional (not Fannie/Freddie) ARM loan can refinance easier with the need for a lesser appraised value.

It’s not surprising that FHA loans are the loan of choice for many.

If you do have 20% down and your credit score exceeds 720, then there is no question that you should use a conventional loan and avoid the negatives with FHA. But for many who don’t – FHA opens the door.

So if I haven’t said it enough times in the last 30 days, I’ll just keep saying it. Now is a great time to buy your first home or trade up.

Let my FHA loan open the door – check it out today!

Affordability

What does a 0.25% increase in the interest rate do to your mortgage payment?

On every $100,000 borrowed, a 1/4% increase in the mortgage rate will increase the payment by around $16 per month. 1/2% is a $32 per month increase; 1% is a $64 per month increase and so on.

On a $200,000 loan, a ¼% increase will affect your monthly payment by $32, ½% will increase it by $64, and so on.

Approvability

If based on your income you were qualified to purchase up to a maximum of a $200,000 home and all else remained the same (your income, property taxes, ins, down payment, closing costs, etc) and the interest rates went up by ½%:

You would then qualify for a $190,000 home instead of a $200,000 home.  Make sure you read through this entire post, the relativity section will apply here.

Strategy

Frankly, you should not be buying a home because the rates are low.  In fact, the rates relative to two years or ten years ago is an irrelevant factor in your decision.  I suggest the following priorities when deciding whether to make a move up or to buy your first home. Consider the following questions:

1. Are you financially ready for this? If you have credit card debt that you don’t pay off each month and you have no emergency fund, you should consider taking care of those things before you enter the housing market. Getting into a home with your last dollar for the down payment is not a good way to start as a home owner. Water heaters cost $350. Furnaces cost $1500 or more. A new roof is $3000 if you do it yourself. Appliances are $500 each. Home warranties can offset some of this cost if you experience them in the first year, but after that the bill comes to you. These things will happen. You need to be ready in advance.

2. Can you afford the home you are purchasing? Lenders will still lend more than they should to most buyers in my opinion. A good test is to determine if you can make the payments on a 15 or 20 year loan before you write the offer. That way you have some cushion. You can always use the 30 year mortgage – but paying it down faster or having extra money to invest in a ROTH IRA or to buy your next car is a good idea.

3. Is the home a good deal? In Michigan right now, any home you buy will cost you less than if you purchased it three years ago. Still, work with a Realtor that can give you market data that will support your offer and take into consideration the condition of the home and make a list of the improvements you will need to take care of after closing.  Add this up before you sign.

4. Did you notice I did not mention interest rates? Rates are a function of the total market and you cannot control them. You can control the answers to the above three questions. Be financially sound, purchase a home you can afford and make sure you don’t pay too much for the home. Then make sure you compare your rate to the market so that you know you are getting a fair rate and you will do well buying a home regardless of what the rates are.

Relativity

In reality, rising interest rates will apply downward pressure to the prices of homes – if rates rise you will likely pay less for the home than you would have had they stayed low. Slightly higher rates are good for you in the long run for this reason. Money, interest, income, prices, inflation, etc are all relative. You need not worry about them too much relative to each other.  Remember that the low rates in 2003 were a huge contributor to rising home prices at that time.  The reason the Fed has been trying to keep rates low is because it wanted to stimulate home prices and sales.  It might make more sense to purchase a home during an unstimulated market than it did during the past 24 months.

The Point

Make good financial decisions for yourself personally based on your own personal economy and let the greater economy take care of (or not take care of) itself. Just because everyone is buying a home does not mean you are ready. But, if you are ready, now is a very good time to make this happen.  The next few years will be a great time historically to purchase a home based on price per square foot of living area.

Well they don’t have to.  We cannot know the future.  New and unknowable information creates the future for us, and even though we are told that certain things are going to happen, we don’t know for sure that they will until they do.

Let me give you an example.  Most people are sure that rates will rise this year.  But if you asked them to bet their $1,000,000 retirement account double or nothing on it, they wouldn’t do it.  So are they really sure?  They must not be or they would make that bet and double their money.

Yet we can make prudent decisions based on what we do know.

We know that the price of Mortgage Backed Securities determine interest rates.

We know that when the prices on MBS rise, rates go down.

We know that there have traditionally been two main buyers of Mortgage Backed Securities – Wall Street Investors and other countries (China mostly).

We know that in the past, when the Stock Market is struggling, market timers on Wall Street have an appetite for Bonds and MBS.

We know that in December last year the US Government, through the Federal Reserve, began buying them too as way to drive the prices up and bring the rates down.  They became a third buyer of MBS.

We know that this worked – over the last year, rates have been very low.

We know that the US now owns more than 1 trillion dollars in these debt instruments, and we know what they have been saying about that.

They’ve said that they will continue to buy but slow down that effort.

They’ve also said that over time they will want to get rid of them.  That means that they will flip from being a buyer to being a seller.

So right now, the MBS market has three buyers that all have a hefty appetite.  The prices are very high and rates are low reflecting this reality.

Soon, we will likely lose one buyer altogether as the Fed stops buying.

And when the Stock Market heats up, the emotional public will make investments there again rather than in the MBS side of things.  Who knows when that will happen?

China threatens, but so far has not made any substantive changes in their buying patterns.

The US will likely become a “seller” rather than a buyer.

So the long story short – the current demand for these MBS could turn into an over-supply and falling prices, causing the rates to rise.

That said, I think as consumers, we ought to make decisions based on what we know now.  Rates are very low today.  5.25% is available with no points and no origination fees if your home’s value is higher than what you owe and not much worse than that if the value is less than what you owe.

Mortgage processing is bearable again too.  If this works for you, then you should take action now rather than waiting.

Any day now, high demand could flip to extra supply, and rates would rise if that happened.

Oh, and pay off your credit cards and car notes too.  You will want to have extra cash around if that happens. And those who do will have very good investment opportunities available to them.

The reasons given for this are many and varied:

1. Homeowners don’t believe they can refinance because the value of their home is too low.
2. The costs are too high because of all of the rate and pricing adjustments that Fannie Mae and Freddie Mac are levying.
3. The second mortgage notes they hold are prohibitive.
4. Some wisely hold back because they foresee a time soon that they will be selling their home and then the cost they paid and the rise in their loan amount would not be earned back in time.
5. Rates will be rising soon and so I probably won’t have time.
6. I’ve even heard one client tell me that they did not believe in the government stimulus, so if using the new Fannie Mae rules that allows for refinancing a lesser value home as the only way they could get it done well, then they weren’t interested.

What are they serving at those tea parties!?

One of my featured posts is called “My Economy vs. THE Economy”, this is the same idea.  Every family’s situation is different and so there is no one right answer for every family

Over the next few days, I will write about four or five situations where I advised against my client going forward with a refinance.  I’ll change the numbers enough so that no one will find themselves in the analysis – but the principle will remain.  Then I’ll give a scenario where if it were different it may have changed my mind.

The point in all of this is to gain the kind of depth of information that is necessary for me to put myself in their shoes and then tell them what I would do given certain assumptions if I were them.  Since no two situations are a like, be sure not to find yourself too quickly in any one situation.  Get the facts in your situation.

Here is the moral of this week’s posts:

If you ought to participate in the most beneficial mortgage market of all time, then don’t hesitate, rates will not wait around all year for you.  But if you shouldn’t, then don’t let all the hype convince you otherwise.

You can always call my office for a free 15 minute phone consultation.

I hope these help you!

I was recently contacted again by a gentleman who is in an Adjustable Rate Mortgage – he is getting concerned about the situation and what could happen if inflation rises and/or rates rise.

There seems to be a lot of fear about this in many households.  If you have an ARM type loan and your current loan balance is higher than your home is worth, you may not qualify for any of the wealth redistribution programs out there – so what can you do?

This phone call was like many that I have – I wanted to share it in some detail:

This person has a mortgage balance of around $150,000.  The homes on his street are selling at or around $115,000.  His interest rate is currently around 3%.  He does not qualify for ANY of the programs and his current lender is not willing to modify his loan.  His mortgage has a “capped rate” of 11.95% – that’s as high as his rate could ever go.

Most importantly – he is fine.  And likely, if this describes you, you can be too.

Over the past two years as I’ve been talking with this family, they have paid off a credit card, eliminated a car loan and paid off one student loan.  They have also increased their emergency fund to around $10,000 – this represents almost 6 months of their household living expenses.

This was not easy for them.  They did not get a big raise or get a second job.  They are a one-income family. They have made a lot of sacrifices in the past number of months to get to this point.

As they eliminated other bills and reached their $10,000 emergency fund goal, they kept building up the payment they were making to the next debt account balance they were focusing on.  They have two student loans left for a total of about $18,000.  They are paying $1000 per month toward the two of them.

In 18 more months, they will have eliminated all of their debt, and a few months after that they will have saved enough to purchase their next used car with cash.  It is likely they will reach this goal sooner as they have been able to push their tax refunds toward their goals in addition to their monthly payment.

Here is the good news.  Even if their adjustable mortgage interest rate went up all the way to 12%, they would be able to afford the resulting payment.

They will not lose their home if they make their payments on time.

They will deduct a boat load of interest against their income making their effective interest rate 9%.

And, rates are not likely to go up soon and not likely to rise that high.

In 18 months, when the last student loan is paid off, they will start paying an extra $1000 per month on the mortgage eliminating the mortgage far sooner than the prescribed time period.

The moral of the story is:

Focus on what you can control. Stop worrying about what you cannot.  Don’t be afraid of what has not happened yet.  99 times out of 100, if you do that, you will be more than fine.  You will use the realities of this market to get ahead.

Many will try to scare you and tell you that “rates will be going out of control” and that “you will lose your home” and that “you should never have done the ARM loan”.  Maybe you shouldn’t have done the ARM loan – but that is irrelevant at this point.

Those who are scaring you are more than likely speaking out of their fear and they do not know the facts about your situation.

Get the facts about your situation and get disciplined about paying off debt and saving.  Call my office, I’m glad to help with a plan like the one in the above real life example.

So the simple advice is this:  Use today’s low rates to your advantage – pay off other debt, build a reserve and then pay off the mortgage more quickly or invest prudently.

As a lender during the past 15 years I have written many such loans.  The marked difference between my clients and the general public is that not one of my clients were surprised by the terms, and all who are still in the loan are enjoying a mortgage rate that is around or below 3% right now.  For the record, the way I wrote and sold the loans I do not think “toxic” is the best name to give it.

Never-the-less, the question still remains, what do we do now?

Lets face it, these loans have more moving parts than a swiss watch and most of them should never have been written – I will even include some of the ones I wrote.  Not so much that the product is so scary, but because the uncertainty is more than many want to live with day to day.  Be that as it may, some are still in this deal and we should keep a level head about things.  They still need good advice.

So, I will write this post to MY CLIENTS – and others can listen in – but make sure if you did your loan with another lender, the terms of yours may differ and sometimes quite a bit – I’d be glad to tell you how this advice might change in your situation  – just email or call.  First, a few facts:

I still have this loan on my home.  I don’t have plans to get out of it.  I am not afraid.

The rates on these loans are VERY VERY low.  The rates can rise quickly.  The one month LIBOR is what they are tied to – this tracks closely with the Federal Funds Rate (which is Prime minus three).  Both are around 1/4% right now.  Thats 0.25%.

The Fed is “saying” that they will keep this rate unchanged for “some time”.  Many on the board have speculated that they will not raise rates in a meaningful way for two more years.  We cannot know what next month will bring.  Inflation is the real enemy and the Fed will raise rates to keep inflation at bay.

The US Bond Market is currently pricing into its bond yeilds a 10 year inflation rate of around 2.7%.  Many fear that inflation will “have to be high” in the future because of all of the spending in Washington.  The bond market disagrees with “many” who ever that is.   High productivity in business coupled with high unemployment are making a great case for a slow recovery and a low level of consumer price inflation.  Re-read the previous fact to remember why this is important.

Many home owners would refinance out of the loan they have, but can’t because they owe more on their mortgage than their home will presently appraise for.  Join the crowd on that one.  Most 30 year fixed type mortgage holders are in the same boat.

So Evan, what should I do now?

1.  Eliminate all of your other debt.  Car loans, Credit Card balances, Student loans, etc.  This is one reason I recommended this loan – to aid in “other debt” elimination.  If you eliminate your car loan(s), and credit cards then you will no longer have those payments to make.  The amount of those payments almost always exceeds the worst case amount that your mortgage payment could rise if rates went up.

2.  If you have no other debt (and you did your loan with me) then you are investing the difference of what your old payment used to be and the new lower payment that this ARM created.  You can either keep investing the difference, or start paying the difference to the mortgage.  I have yet to meet with a client that has been keeping this up, that has not gotten great results from this system.

If you have no other debt, you actually have one more option.  You could take some of your invested dollars and pay down the mortgage to the amount necessary to qualify for a low 30 year fixed rate.  You may feel more comfortable in a fixed rate loan – who knew 30 year rates would hit 5%!?  Locking in may be right for you.

3.  So you have not been able to invest and are having trouble eliminating other debt.  We should talk about a cash flow plan and whether a refinance is doable for you.  You might feel more comfortable in a fixed rate loan.

4.  Some of you have moved out of that home and are renting the home out.  This is a great investor loan.  Rents and Rates tend to follow each other.  Over time, as rates may rise, so will the rents you receive – these will offset each other a little bit.  Make sure you have a good side fund of cash for emergencies.  This is wise no matter who you are, but if you are an investor, even more so.

So to wrap up:

Whether you think I should have done these loans or not, I may be the most qualified lender in Michigan to help you through it.  I have more experience than most in terms of years and I also did one thing that almost all loan officers who sold these loans did NOT do – I wrote the loan on MY home.  For great, level headed, and well informed advice, call me.  I’m always learning and I’ll always be here to help.

But, according to New York Fed Bank President William Dudley, the Fed is not on “auto pilot” and will restart the MBS purchasing program if mortgage rates spike.  “If there is a sharp turn in the road” Mr Dudley said, the Fed would intervene.

This would potentially stave off what many feared would be a sharp increase in interest rates just as the new Refinance Programs have gotten going.  Normally the two main buyers of Mortgage Backed Securities are China and Wall Street.  For the past year, the US Government has been a major buyer forcing the prices of these debt instruments up and the yeilds (or interest rates) down to record lows.

So, if you are in the market for a new home or a low rate refinance – don’t expect rates to go down any further because of this news; but you may have  a little longer before they rise sharply.  It looks like the party isn’t over just yet.  Stay tuned.

CLIENT:
ok wanting your advice on this . We have the house up there in MI that we have an ARM on and we are so upside down that its ridiculouse , then we have the house down here in [out west] that we bought at the bottom of the market and are ( hopefully ) going to make money on . We are going to sell the house in MI as soon as is financially profitable to do so , and i was thinking of re financing the one up there . I don’t know how the market is up there and i havn’t the time ( work commitments and all ) to work this out , so i would appreciate some in[ut from you guys .

Due to the distance involved we would really like you guys to handle everything if a re fi is the way to go . I’m not looking long term on this ( like 20 years ) we just need to sell and make a few, and call it a right off if needs be

MY RESPONSE:
Hey, great to hear from you – hows the weather out west!?

Send me your mortgage statement and I will confirm my thoughts with it, but as I recall, your loan rate is currently less than or around 3% right?  Your payment has got to be quite low as a result and even if you made the lowest payment option you are given each month you would be reducing your principle balance considerably over the course of a year.

In addition, the Feds just came out with a statement that they would like to keep short term interest rates “very low for a very long time”.  They are using the year 2012 as the first date they will be moving their rate.  This is never a sure thing but I certainly like the sound of this more than the sound of hyper inflationary rising rates!

My advice for anyone in an ARM type mortgage who will be holding onto their home for just the next 3 to 5 years is to NOT refinance.  Fear on the one side will cause us to move toward the certainty of a 30 year mortgage and incur whatever expense it takes to get it.  On the other side, some are in a low rate ARM mortgage and are making their decision based on greed.  As long as greed is the motivator, they will likely wait too long trying to hold onto the relatively small amount of savings and then in a year or two they will end up in a higher fixed rate for the next two decades as a result.

In your case, you don’t have a long term outlook on this home or mortgage.  The level headed approach is to sit tight and make your payments.

That said, you don’t have an option to refinance right now anyway because your home is worth less than you owe on it and neither Fannie Mae nor Freddie Mac are the current paper holder on your mortgage.  None of their open access programs will apply.  Enjoy 3% it will likely be around a little while.

Thinking back, when we wrote this loan for you a few years ago, we said that this could be the last mortgage you write on a home in Michigan.  At that time we did not know you would be moving West (we thought East) but we DID like the fact that you would not be spending money on closing costs again here.

I wrote a post a while back called YOUR economy vs. THE economy.  I think YOUR economy is fairing quite well in THIS ecomomy.  Lets add it up:

1.  You were able to secure a VERY low price on a home out west that you will be in for a longer period of time.
2.  On the home you can’t sell right now you have both a very low mortgage rate and a tenant making your payment.

It looks to me as though you are landing right on your feet!

Your thoughts?
evan

home mortgage

Client:

I received your email and have had time to review it.

Your mortgage adjustment letter and your note don’t match up, the letter they sent you gives you results that are better than the note you have from them.  Based on your note, your rate should be 3.625% and they are going a full quarter lower than that.  ???  In addition to that, they are saying that your “margin” is 2.75% and your note shows it to be 3.0%.  That will be slightly beneficial for you in years to come.

You have a couple of options:

1. Try to refinance quickly while you are employed – 5.0 to 5.25% is what you can expect if your credit scores are good – you may qualify for the new “open access” terms that waive the negative results of a low appraisal.

2. Ride this out in the ARM and enjoy the lower rates while they are with us.  The Fed just said that they would like to keep rates on ARMs very low for the next 30 months.  At the same time though, they said that long term rates would need to rise as a result.

If you said that you would be selling this home in the next 5 years, I’d say, the ARM is not that great a risk -think about sticking with it.  If you wanted this to be your “forever home”, then refinance it if you can because long term rates will never be this low again.

Feel free to call me when you can and we can go over details of this.  I’ll archive this data and stay in close contact with you as you have questions or concerns.

With respect to payment, if you don’t refinance with us, I’ll bill you as we discussed.   That said, if I didn’t get payment from you for a long time, that would be okay (and I’ll never call you for it) I just need to be consistent with clients on the front end.

I trust that the LORD will see you and I through all of our challenges, including the big ones.  I know you know this, but even the strongest among us need the reminders.

Best,

Evan

Interest rates are the result of the yield on Mortgage Backed Securities (MBS).  When MBS are sold to investors they are purchased at varying levels of demand.  If they are in low demand, the price of the security will go down and the yield (or return) will go up.  This will result in higher rates to the consumer.  When there is a high demand for these securities, the price rises and the yield falls – interest rates in turn come down.  This is simple supply and demand economics.

Why does the Yield travel opposite the Price?

This is more easily understood using an example.  If I could buy a home from you and guarantee my profit when I sell it, that would be like buying a bond.  Lets say I guarantee my profit up front to be $10,000.  If I had to purchase a home at $100,000 to make a $10,000 profit then my return (or yeild percentage) would be 10%.  But if I could buy a home for $50,000 and gain the same $10,000 profit, then my yield would be 20%.  A bond or a mortgage backed security is simply an investment with a known profit and a variable price.  So when the price goes down the fixed yield – as a percentage - goes up.

Who buys MBS?

Until last December (2008) there were two main buyers of these types of guauranteed yeild investments.  Wall Street is the main investor – mutual fund companies use these securities to offset risk of owning stocks.  The second investors are foreign countries, mostly China and a few others.   (China and other Asian countries currently own over 1/3 rd of our debt.)  Last December, on their own, interest rates were around 6% to the consumer on a 30 year fixed rate loan with no points based on the activity of these two main buyers.

Enter the US Federal Reserve.

In an attempt to bring long term interest rates to a target of 4.5% and moving as fast at the Treasury’s printing presses could carry them, the US government became a competing buyer for this kind of debt creating a “false demand” for MBS which drove the prices up.  This in turn caused the yields to decline and at their lowest, the consumer was able to lock in at 4.875% with no points a time or two during the past year.

When will they Stop?

The Fed decided originally to spend around $750 billion buying treasuries, bonds and securities and then earlier this year bumped that to $1.25 Trillion.  As of last Friday $977 billion have been spent leaving $277 billion in purchases over the 22 weeks that remain in the program.  The average purchases have been around $20-25 billion per week all year.  This will decline to about $12 billion per week through the end of the year and then drop off.

Prices will almost assuredly fall.

If that happens, the rates WILL rise.

One of the financial magazines I read weekly is Business Week. It can be a little bit politically charged, but depending on who’s writing the economics ‘short’, it can be very good.

This week’s is written by Peter Coy. Google his name and you’ll find him to be a bit pessimistic on the economic recovery and not quick to get on band wagons that others are riding. His is a level-headed report of the facts, and he doesn’t generally over play his theories. Just the kind of guy you want to hear good news from.

The article I’m referring to – linked here – will not disappoint you. It explains simply and clearly why Bernanke is so committed to a VERY low rate standard.

His reason in a nutshell:  The economy at large has a ton of excess capacity right now, which will take a long time work through. What do we mean by capacity? You see it practically as high unemployment and high inventory of homes on the market. Both examples are resources that are more plentiful, more in “supply” than we need. It will take a lot of economic growth just to work through what is already here and to use up this excess.

Another reason for extra capacity is the recent rise in productivity. The productivity numbers rose again this month, though they were expected to remain flat. So, not only do we have an excess in resources, we;re also getting more efficient at producing them. This will create slow growth in the economy, in Big Ben’s opinion, and support for his theory is growing.

Take five minutes and read the article. You might also consider who you know who might appreciate this information.

Some concluding thoughts:

WHAT IF BERNANKE IS RIGHT?
Then we’ll have slow economic growth and keep interest rates low for some years to come. We can live with this. Let’s be honest – putting our Lansing hat back on – we’ve been living with it for some years already. But here is where we might see light on the horizon – a bright spot. It may just be Mid-Michigan’s turn for moderate jobs growth. If this happens while the rest of the country (world) is lagging, then we could have both rising home values AND low rates. Let’s not be too much the ‘realists’ to think this couldn’t happen.

WHAT IF BERNANKE IS WRONG?
Then the economy at large heats up, rates rise sooner – not a lot, most likely, but sooner. AND our 401k’s rebound again. We can handle this too! Even if he’s wrong, 1982 inflation and rates are not a likely event based on the slow growth expectations.  At least not for a while.  Most of us who need a fixed rate will get one while they’re low and few will remain by the time anything wild happens.

WHY IS THIS IMPORTANT TO ME?
If you are buying a home or refinancing a mortgage right now, then you should still consider a fixed rate.  Mostly because they’re very low right now (see my blog 24/7 for daily averages).  If you are currently in an Adjustible Rate Mortgage, you should get some advice as to what to do.  Your rate will likely be very low for the next few years.  Let’s not allow fear or greed to dictate these decisions.  A good level-headed decision based on the facts of your situation and the realities of your goals is what is needed.

LAST THOUGHTS
Let’s also be very honest with ourselves. As “smart” as Mr. Bernanke is, he does not know or hold the future.  Only time will tell if his contributions were beneficial. He’s helping us navigate right now, and I am thankful for that, as am I thankful for all like him who are in positions of great weight and difficulty. I would urge us to remember the phrase written ON our money when we think ABOUT our money:  “IN GOD WE TRUST”.  After all, low rates, housing credits, and three shifts running at General Motors will all pass away in time.