HomeInterest Rates Stay Low
by Michael W. Licamele III
A re you still waiting for a lower rate to refinance? Are you still rentingbecause you think owning a home costs too much? Why? If there were evera time to benefit from low interest rates, it is right now. Most interestrate forecasters predict that while rates may stay in the same low rangefor much of the year, they have nowhere to go but up in the future. So whilethere is no immediate rush, most mortgage industry analysts recommend actingsooner rather than later.
Is now a good time to buy a home? Let's use a typical home buyer as anexample. When 30 year fixed rates were 8.25% in mid-1996, a $200,000 mortgagecost $1,502.33 per month. Today, with one to two points borrowers can getthat same $200,000 mortgage for about 6.75% with a payment of only $1,297.20per month. Savings of $205.13 per month add up to $2,461 per year and $73,846over the life of the loan. Families can take that savings and use it tosave for college education, retirement or spend it for a better qualityof life.
Alternatively, borrowers who had been shopping for a home last year butfelt priced out of the market may find that they can now afford the moreexpensive home they want for the same monthly payment. For example, a coupleearning $72,000 per year can afford a housing payment of approximately $1,980per month according to standard underwriting guidelines. Assuming propertytaxes and home owner's insurance of $350 per month, that couple could afforda mortgage of about $217,000 with last year's 8.25% 30 year fixed rates.Today, with a 7% rate, the same couple could afford a mortgage of $245,000-nearly13% more with the same income!
Why Are Mortgage Rates So Low Now?
Interest rates are determined by a variety of factors, including thestrength of the economy, inflation, unemployment levels and government budgetdeficits among others. The Federal Reserve, under the present leadershipof Alan Greenspan, monitors economic factors to determine and implementa national monetary policy. The overall goal of this country's monetarypolicy is to foster economic growth and employment without letting inflationget out of control.
The good news for the U.S. economy is that over the past few years allof the forces that would tend to encourage lower interest rates have converged.The federal budget deficit has decreased from over $300 billion per yearto zero this year. Inflation is as close to non-existent as ever, with pricesincreasing less than 2% per year. Unemployment rates have dropped to levelsthought not possible in the 1980's. Finally, the economy has been growingat a steady but not overwhelming pace of 3% to 4% per year. Recognizingthese positive trends, the Federal Reserve has maintained a neutral policytoward interest rates over the past year, moving the short-term FederalFunds rate up only once by one quarter percent back in March of 1997.
Mortgage interest rates, which find their levels primary from the U.S.treasury bond market, have steadily decreased since the beginning of 1997to levels seen only briefly in late 1993. 30 year fixed rate loans havedecreased from approximately 8.50% to 7.00% and below from January 1997to March 1998. 15 year rates now range from 6.50% to 7.00% , down from nearly8.00%.
While fixed rates have decreased substantially, adjustable rate mortgage(ARM) programs such as 1 year ARMs, 3/1, 5/1, 7/1 and 10/1 ARMs have notdropped nearly as much as fixed rates. This is due to a financial phenomenonknown as the flattening of the yield curve. In simple terms, all this meansis that short term interest rates (on which ARMs are based) are now almostthe same as long term interest rates (on which 30 and 15 year fixed rateloans are based). Usually short-term rates are much lower than long-termrates. In 1993, fixed rates were at 7% and 5/1 ARM's had start rates ofaround 5%, a 2% difference. Today, fixed rates are at 7% but 5/1 ARM's stubbornlyremain at about 6.75%, a scant 1/4% difference.
What's Coming Next?
Because the interest rate yield curve is so flat, either one of two interestrate scenarios will occur next. Either short-term rates will fall, or long-termrates will rise. If long-term interest rates rise, 15 and 30 year fixedrate mortgages will increase in tandem. For short-term interest rates tofall, the Federal Reserve would have to lower its key federal funds anddiscount rates. Because short-term market interest rates have decreasedalmost to the point of these benchmarks, neither short-term nor long-terminterest rates have much room to decrease further at this time.
So what is the likely scenario for the rest of 1998? As far as most analystssee it, 1998 should be similar to 1997, with slightly slower growth in theeconomy and little or no inflation pressures. Unless the Federal Reservemoves to lower interest rates, we will not see mortgage rates much lowerthan their record lows of the early part of 1998. Few analysts are now predictingany type of decrease in interest rates by the Federal Reserve. If the Asianeconomic crisis worsens, there could be a temporary drop in rates as investorsmove money to safe United States treasury bonds and mortgage securities.On the other hand, should any sign of inflation appear on the horizon, swiftincreases in mortgage rates will result.
Refinance Strategy
Given the 1998 outlook for stable rates with an upward future bias, homeowners seeking to refinance should select the loan program that is bestfor their needs and lock into a rate immediately. Conventional borrowersseeking loans of less than $227,150 would probably be best off selectinga fixed rate mortgage unless they plan on leaving their home within thenext five years. Adjustable rate programs simply do not offer a large enoughsavings to justify exposing a borrower to a potential rate time at somepoint in the future.
Borrowers with loans over $227,150 have a different calculation becauseof two simple facts. First, fixed rates for these jumbo loans are usually1/4% to 1/2% higher than conventional fixed rate loans. And second, evensmall rate differences can make a large difference for larger loans. Withthe increasing ease of refinancing, many loan borrowers do not have to worryabout interest rate changes three, five, seven or ten years down the roadbecause they know that they can almost always obtain a new adjustable ratemortgage with a lower starting rate.
Home Buyer Strategy
As demonstrated above, home buyers will find that they can afford muchmore than a year ago simply due to lower interest rates. Given today's record-lowrates, first-time home buyers should consider selecting a basic 30 yearfixed rate mortgage and call it a day. Buyers expecting to keep their homefor more than five years can pay one or two points to get their rate below7% if they can afford it at closing. Buyers strapped for closing costs ornot sure how long they will keep their home can request a no-points loanwith a rate slightly above 7% and still have an extremely low mortgage payment.
No matter what a borrower's current situation, the opposite of the oldadage is true: good things come to those who do not wait.