- The Washington Times - Thursday, September 14, 2006

I have warned home buyers that, despite the latest dip in mortgage rates, “floating” an interest rate during the mortgage process can be risky.

For those who are unfamiliar with the concept, a borrower who chooses to float his rate is subject to the changes in the rate until he decides to lock. If rates go down, he wins. If rates go up, he loses.

The problem with floating a rate over the short mortgage-processing period is that even in a general downward trend, there’s no gauge to determine when rates will hit a temporary spike.

Your lender may quote a rate of 6.50 percent on Oct. 1. You are due to settle Oct. 15. Because rates have been in a downturn over the past few months, you decide to float the rate. Then, suddenly, some unfavorable political news comes out of the Middle East, sending markets reeling. Mortgage rates spike up. You end up locking your rate at 6.75 percent the day before your settlement. A month later, after the market had digested the news, rates settle back down again.

You, however, are stuck with 6.75 percent because you got caught floating your rate when interest rates temporarily spiked up.

The point is this: Interest rates are very hard to predict over a short period. Let’s take a more “macro” look at the interest-rate picture. What’s in store for mortgage rates in 2007?

I poked around the Internet and found that most sites and bloggers predict higher mortgage rates in 2007. I then noticed that most of the predictions were made in 2005, when the economic picture was far different from what it is today.

For what it’s worth, let me give you my take.

There is one easy way to predict the movement of mortgage rates: Rates will fall if the economy weakens and rise if the economy overheats and inflation worsens.

Having said that, let’s get out of the interest-rate arena and enter the economic arena. Where is the economy headed? Some thoughts:

• Overall inflation over the past couple of years has been hovering around 4 percent, far higher than what most economists would judge as an acceptable level. However, the so-called “core” inflation rate, which excludes volatile and uncontrollable food and energy prices, remained closer to 2.50 percent. Translation: Inflation may not be as big a threat to the economy as some think.

• Recent economic reports are full of signs pointing to a slowing economy. Sales of durable goods have weakened, wages are stagnant, and despite low core inflation, the rise in energy costs is bound to reign in economic growth.

• The housing boom is clearly over. Many analysts are predicting not only a move back to a balanced housing market, but a swing to the other direction, resulting in a housing glut and falling prices. Economically and psychologically, such a situation could stifle spending even more.

• The Fed raised short-term interest rates 17 consecutive times before pausing on Aug. 8. This credit policy is likely not just to keep inflation contained, but to stifle economic activity.

Though it’s possible that none of this will pan out, the stage is set for an economic slowdown or even recession.

The bottom line? Anemic economic growth and contained inflation usually point to lower interest rates in the future, including mortgage rates.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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