Twisting to Economic Recovery

Who would have thought that rates on a thirty year fixed mortgage would drop below 4.0%? Although rates bounce around slightly from day to day, this is right about where they’ve maintained the last couple weeks for many loans below $417,000. What makes this recent drop in interest rates most interesting is the Federal Reserve’s policy that served as the primary force to drive rates down.

On Wednesday, September 21^st, the Federal Reserve announced “Operation Twist” as its most recent plan to stimulate economic recovery. Under this plan, the Federal Reserve would diminish its short term holdings and replace them with more long term assets. From a taxpayer perspective, the best part of this plan is that it doesn’t add anything to the Fed’s balance sheet. The source of capital comes from short term holdings that mature as well as principle payments received on the Fed’s entire balance sheet. This trade-off of short term transitioning to long term is where the “twist” comes from.

In some ways, this move by the Fed was largely anticipated and expected by global investors. Announcements from the Fed are rarely secret or surprising. But this time it was a little different. There was a little twist to the “twist.” In an unanticipated move, the Fed announced that it would specifically be reinvesting into agency mortgage backed securities, not just into treasury bonds. This move by the Fed created a surge in demand for these very mortgage backed securities, and with it the added effect of dropping mortgage rates to the lowest ever on record. Within 24 hours of the announcement, rates on a conventional 30 year fixed mortgage dropped to 3.75% with little to no closing costs. This was the market rate on Thursday, September 22^nd.

The record setting rally on mortgage bonds was short-lived, and rates were back up to 3.875% by Friday morning. They pushed further up to 4.0% by Friday afternoon. Since then, the rate on a convention 30 year fixed mortgage has hovered just over or just under 4.0%. The way mortgage bonds are currently trading, it does not appear that 3.75% is going to come back, but 3.875% remains a very attainable rate with little to no cost for well qualified borrowers.

Some homeowners will find it interesting that while the rate on a thirty year fixed mortgage has dropped, rates on shorter term products (10 and 15 year terms) have actually gone up during the same time frame. This may have been the intent of the Fed all along. Short term mortgages carry higher payments that force homeowners to give more money back to the banks, while long term mortgages feature lower payment and allow homeowners to have more discretionary spending money. Our economy is stimulated when consumers spend money. If a homeowner can refinance into a new 30 year mortgage that saves them $200 per month on their mortgage payment, that individual now has $200 additional disposable income to stimulate the economy. Operation Twist is the Fed’s attempt to put more money directly in the hands of consumers.

As we all know, the government already tried to help the economy by giving money directly to the banks. That didn’t work. Instead of making that money available to consumers, the banks used the government money to make acquisitions and shore up their balance sheet at taxpayer expense. It’s along this same reason why the Fed would prefer homeowners not take a shorter term loan which gives more money back to the banks instead of injecting it into the economy now. Getting the loan paid down faster will provide the homeowner with more disposable cash when the loan is paid off in the future, but our economy needs the stimulus more now than in 15 years. This is the point of “operation twist” and the reason why the Fed is investing in (or subsidizing) thirty year fixed mortgages.

As usual, there is more to life than pure absolutes. Rates are so low right now that individuals have the opportunity to lower their rate in a manner which will both lower their monthly payment and still help get the loan paid off faster. A new 30 year fixed doesn’t have to be paid off in 30 years. Someone who just obtained financing 2 years ago and doesn’t want to start all over with a new 30 years can simply request a 28 year loan (yes, these exist). Since conventional loans don’t have a prepayment penalty, they can also take the 30 year loan and make the payment equivalent to a 28 year amortization to get the loan paid off in the same remaining timeframe. If they can do this at a lower rate than what they currently have, they’ll be able to save themselves some money every month at the same time. This is good for the homeowner, and good for the economy. Finally, we have a “win-win” proposal out of Washington.

Arnaud Dufour
Sr. Mortgage Banker

adufour@dljfinancial.com
714-677-4107

CA DRE # 01360217
NMLS # 335758