Interest Rates Stay Low

by Michael W. Licamele III

A re you still waiting for a lower rate to refinance? Are you still renting because you think owning a home costs too much? Why? If there were ever a time to benefit from low interest rates, it is right now. Most interest rate forecasters predict that while rates may stay in the same low range for much of the year, they have nowhere to go but up in the future. So while there is no immediate rush, most mortgage industry analysts recommend acting sooner rather than later.

Is now a good time to buy a home? Let's use a typical home buyer as an example. When 30 year fixed rates were 8.25% in mid-1996, a $200,000 mortgage cost $1,502.33 per month. Today, with one to two points borrowers can get that same $200,000 mortgage for about 6.75% with a payment of only $1,297.20 per month. Savings of $205.13 per month add up to $2,461 per year and $73,846 over the life of the loan. Families can take that savings and use it to save for college education, retirement or spend it for a better quality of life.

Alternatively, borrowers who had been shopping for a home last year but felt priced out of the market may find that they can now afford the more expensive home they want for the same monthly payment. For example, a couple earning $72,000 per year can afford a housing payment of approximately $1,980 per month according to standard underwriting guidelines. Assuming property taxes and home owner's insurance of $350 per month, that couple could afford a 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-nearly 13% more with the same income!

Why Are Mortgage Rates So Low Now?

Interest rates are determined by a variety of factors, including the strength of the economy, inflation, unemployment levels and government budget deficits among others. The Federal Reserve, under the present leadership of Alan Greenspan, monitors economic factors to determine and implement a national monetary policy. The overall goal of this country's monetary policy is to foster economic growth and employment without letting inflation get out of control.

The good news for the U.S. economy is that over the past few years all of the forces that would tend to encourage lower interest rates have converged. The federal budget deficit has decreased from over $300 billion per year to zero this year. Inflation is as close to non-existent as ever, with prices increasing less than 2% per year. Unemployment rates have dropped to levels thought not possible in the 1980's. Finally, the economy has been growing at a steady but not overwhelming pace of 3% to 4% per year. Recognizing these positive trends, the Federal Reserve has maintained a neutral policy toward interest rates over the past year, moving the short-term Federal Funds 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 1997 to levels seen only briefly in late 1993. 30 year fixed rate loans have decreased from approximately 8.50% to 7.00% and below from January 1997 to March 1998. 15 year rates now range from 6.50% to 7.00% , down from nearly 8.00%.

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 not dropped nearly as much as fixed rates. This is due to a financial phenomenon known as the flattening of the yield curve. In simple terms, all this means is that short term interest rates (on which ARMs are based) are now almost the same as long term interest rates (on which 30 and 15 year fixed rate loans are based). Usually short-term rates are much lower than long-term rates. In 1993, fixed rates were at 7% and 5/1 ARM's had start rates of around 5%, a 2% difference. Today, fixed rates are at 7% but 5/1 ARM's stubbornly remain 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 interest rate scenarios will occur next. Either short-term rates will fall, or long-term rates will rise. If long-term interest rates rise, 15 and 30 year fixed rate mortgages will increase in tandem. For short-term interest rates to fall, the Federal Reserve would have to lower its key federal funds and discount rates. Because short-term market interest rates have decreased almost to the point of these benchmarks, neither short-term nor long-term interest 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 analysts see it, 1998 should be similar to 1997, with slightly slower growth in the economy and little or no inflation pressures. Unless the Federal Reserve moves to lower interest rates, we will not see mortgage rates much lower than their record lows of the early part of 1998. Few analysts are now predicting any type of decrease in interest rates by the Federal Reserve. If the Asian economic crisis worsens, there could be a temporary drop in rates as investors move money to safe United States treasury bonds and mortgage securities. On the other hand, should any sign of inflation appear on the horizon, swift increases in mortgage rates will result.

Refinance Strategy

Given the 1998 outlook for stable rates with an upward future bias, home owners seeking to refinance should select the loan program that is best for their needs and lock into a rate immediately. Conventional borrowers seeking loans of less than $227,150 would probably be best off selecting a fixed rate mortgage unless they plan on leaving their home within the next five years. Adjustable rate programs simply do not offer a large enough savings to justify exposing a borrower to a potential rate time at some point in the future.

Borrowers with loans over $227,150 have a different calculation because of two simple facts. First, fixed rates for these jumbo loans are usually 1/4% to 1/2% higher than conventional fixed rate loans. And second, even small rate differences can make a large difference for larger loans. With the increasing ease of refinancing, many loan borrowers do not have to worry about interest rate changes three, five, seven or ten years down the road because they know that they can almost always obtain a new adjustable rate mortgage with a lower starting rate.

Home Buyer Strategy

As demonstrated above, home buyers will find that they can afford much more than a year ago simply due to lower interest rates. Given today's record-low rates, first-time home buyers should consider selecting a basic 30 year fixed rate mortgage and call it a day. Buyers expecting to keep their home for more than five years can pay one or two points to get their rate below 7% if they can afford it at closing. Buyers strapped for closing costs or not sure how long they will keep their home can request a no-points loan with 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 old adage is true: good things come to those who do not wait.

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