Where are the 4.5% interest rates?
4.5%. That seems to be the magic number. It represents the recent low point for rates and also seems to be the expectation of many homebuyers and refinance clients. I want to address three questions with this post:
1. How did 4.5% become the target mortgage rate in the minds of so many people?
2. Why did rates just briefly touch that level and then move higher again?
3. Will they get there again?
Back in November 2008, then-Secretary of the Treasury Hank Paulson said that a key to the housing recovery would be mortgage rates around 4.5%. He floated a trial balloon suggesting a program that would make that rate available to home buyers. The suggestion did not go very far, but mortgage bond traders interpreted his comment as a de facto governmental target interest rate for 30 year fixed rate mortgages. A few weeks later, the Federal Reserve announced that they would begin buying up to $500 billion worth of mortgage backed securities (i.e., mortgage bonds) between January and June 2009. In the minds of traders, that would be the vehicle to drive rates down to the 4.5% they were expecting.
The Fed did indeed begin buying mortgage bonds in large quantities at the first of this year. During the first couple of weeks, they purchased mortgage bonds with coupons* low enough to trigger a drop in rates to 4.5%. That rate drop was "assisted" by the market expectation as previously mentioned. However, after the first couple of weeks, the Fed began buying mortgage bonds with higher coupons. That allowed rates to move up into the 4.75% - 5.25% range we've seen over the last several weeks.
So why did the Fed shift it's buying to higher coupon bonds? Two reasons come to mind. First, by buying higher coupon bonds, the Fed will recover their money sooner than if they buy lower coupon bonds. The loans with the higher interest rates will pay off more quickly as people refinance. Second, when the Fed was buying lower coupon bonds and rates dropped to 4.5%, the refinance market went crazy. Everyone was lining up to take advantage of the low rates. That overwhelmed brokers (like me) and the lenders we place our loans with. The lenders were not prepared for the flood of business. They did not have enough underwriters, processors, or closers. If rates had stayed at 4.5%, the flow of loans would have become an avalanche! I think it is possible - even likely - that the big lenders asked the Fed to give them some time to staff up so they could handle the refinance business.
Now the key question: Will we see 4.5% again? We will if the Fed begins buying lower coupon mortgage bonds and the massive economic stimulus does not show any signs of creating inflation. Whether the Fed will begin buying the lower coupon bonds depends upon which of the two motives I mentioned is the real one! Let's hope it's the latter.
Disclaimer: Nobody, including me, knows for certain where rates are going! The comments you've just read are my opinion only. They should not be considered as advice for locking or floating any interest rate nor do they represent a prediction of any future interest rate!
*Mortgage bonds are sold at "coupons" which represent the interest rate paid to the bond investor. The mortgages that secure the bond must have somewhat higher interest rates than the coupon rates to cover the cost of loan servicing and profit for the lender and securitizing firm. Typically, the spread is between 1/2% and 3/4%. A mortgage bond with a 4.5% coupon would be secured by mortgages with interest rates of 5.00% - 5.25%.