JANUARY 24,2010 - For the past year, we've seen mortgage interest rates remain at or near record lows. But, soon we could see the housing recovery tested by rising rates. Why? The Federal Reserve has announced that it will stop buying mortgage-backed securities at the end of March.
 
The interest rate you're quoted by a mortgage lender is ultimately determined by the price of mortgage-backed securities (MBS). What's an MBS? Simply put, these securities provide a way for your lender to sell your loan, packaged together with others, to someone else. This returns money to the lender so they can loan it out again. The price sellers are willing to pay for these securities determine the interest rate your lender must charge.
 
The Federal Reserve ("The Fed") has purchased more than $1.1 trillion of MBS since January 2009. In fact, The Fed bought nearly all of the new residential MBS issued during the past 12 months. If you or someone you know obtained a new mortgage in 2009, it's likely that The Fed owns a piece of it.
 
The Fed's campaign started in November 2008 with an allocation of $500 billion, and was promptly increased to $1.25 trillion four months later. It's been a largely successful initiative in that the goal of keeping mortgage rates near 5% has been met.
 
Only $100 billion remains of The Fed's allocation for these purchases. At the recent pace of $12 billion per week in MBS buying, those funds will indeed be depleted by the end of March. Experts predict that when Fed funds are no longer flowing into the MBS market, mortgage rates could rise nearly 1%.
 
Such an increase in rates would impact buyers' purchasing power. If the interest rate rises from 5% to 6% on a $300,000 mortgage, the borrower's payment increases by $188 per month. This would require either $417 per month in additional income from the buyer to qualify, or a decrease in sales price of about $25,000.
 
While mortgage-backed securities have existed since the 1970s, private issuance of these bonds skyrocketed from 2003-2006. Then, as a result of the mortgage meltdown in 2007-2008, trading for virtually all mortgage related bonds that didn't contain an explicit guarantee from the government came to a halt.
 
Private mortgage securitization, which allowed proliferation of the creative financial products that many believe led to the meltdown, disappeared. The Federal Reserve's $1.25 trillion commitment to the mortgage market delivered much needed liquidity to a market that was in deep trouble. 
 
As a result, the federal government is actively involved in the mortgage market, like never before, as both buyer and seller. The primary buyer is clearly The Fed. The sellers are the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Association (Ginnie Mae). These organizations issue or guarantee virtually all residential MBS at the present time. All three are backed by the full faith and credit of the United States.
 
Ginnie Mae has long been a guarantor of mortgages associated with FHA and VA loans. Fannie Mae and Freddie Mac were originally chartered as private firms and only earned the explicit backing of the federal government when they were forced into conservatorship in 2008. Meanwhile, The Federal Reserve has taken its public role as "lender of last resort" to an unprecedented level.
 
Low interest rates and tax credits for home buyers have provided tremendous support to the housing market at a critical time. With Fed MBS purchases ending in March and tax credits for home buyers set to expire in April, the health of the housing market will be tested.
 
An increase in interest rates will create challenges. But, a 6% rate is still very low by historical standards. Demand for homeownership will continue to be strong. Good deals for buyers are still out there and will be for the next several quarters.
 
We might even see renewed popularity of safely structured adjustable rate mortgages (ARMS). 5 year fixed ARMS, for example, are currently offered at rates more than 1% below 30 year fixed loans and that isn't likely to change.
 
It's important to note that some members of The Federal Reserve's Open Market Committee (FOMC), the powerful 12 member group responsible for monetary policy in the United States, have recently expressed support for extending the MBS purchase program. We'll continue to follow their actions closely.

 

SOURCE: Jeff Anderson

Rancho Capital Group