Last week, the Federal Reserve Board of Governors wrapped up a two-day meeting, declaring it would leave interest rates at historically low levels for an “extended period” to help rejuvenate the economy.
The Fed controls the federal funds rate, the rate banks charge each other for overnight funds. Contrary to what many folks think, when the Fed “raises” or “lowers” interest rates, it doesn’t necessarily translate into higher or lower mortgage rates.
On the other hand, homeowners who have a home-equity line of credit will be glad to hear this news because most HELOCs are tied to the prime rate, and the prime rate will follow the Fed’s direction. That’s one piece of good news: If you have a HELOC, your rate may not start rising until the fourth quarter of this year.
Long-term interest rates, such as Treasury bonds and 15- and 30-year mortgage rates, are governed by market forces. They have remained surprisingly low during a period of unprecedented government spending. Huge government spending can bring down the value of the dollar, causing prices to rise. Having money tied up in investments with fixed yields during an inflationary period is typically a bad investment. Therefore, many analysts predict investment demand in these long-term instruments will drop, causing the prices to drop and making interest rates rise.
So far, this scenario hasn’t played out. There are a couple of explanations.
First, while U.S. debt has exploded and the fear of inflation is serious, the world economy isn’t any better off. Europe, particularly Greece, is in worse shape. This has caused a “flight to quality” into U.S. instruments. When the stability of the world economy is questioned, investors still flock to U.S. Treasury bonds as a safe haven, creating a demand and keeping prices high and rates low. Mortgage rates tend to follow Treasury yields.
Second, and this is my opinion, investors are realizing that mortgage-backed securities are a good deal. One of the major causes of the credit crunch was the unwillingness of individual and institutional investors to invest in mortgage-backed securities. After all, they were burned pretty badly because the days of easy credit resulted in too many bad loans being made. Risky loans and good loans were packaged together and sold as securities. When the bad loans stopped paying, the value of the entire security fell, and investors lost a lot of money.
I can tell you that the mortgage loans I make today are nearly perfect. The stringent underwriting standards are beyond what is reasonable to determine a good credit risk. Lenders are not making questionable loans anymore. I think investors are realizing that mortgage-related products are once again an attractive investment. A steady demand for mortgage investments should keep rates low for a while.
If inflation kicks in, however, we can expect rates to rise.
Henry Savage is president of PMC Mortgage in Alexandria, Va. Reach him at henrysavage@pmcmortgage.com.
Please read our comment policy before commenting.