Wednesday, May 7, 2008

Rates up or down?

Will the recent cut in the fed funds rate translate into lower mortgage rates? The answer is an equivocal yes and no. It's possible we'll see lower rates on some adjustable rate mortgages, but it's no slam-dunk. ARMs are more closely linked to the fed funds rate than fixed-rate mortgages, to be sure, but have only fallen about half a percentage point since September. ARMs played a leading role in the recent foreclosure fiasco, which has kept their rates higher than what would normally be expected.

Fixed-rate mortgages, on the other hand, are driven by rates on 10-year treasury notes. Rates on a 30-year fixed mortgage are typically 1.5 percentage points higher than the rate on the 10-year Treasury note, but because of increased risk perception – brought on by higher foreclosure rates and a stagnating housing market – that premium has expanded to 2.3 percentage points.

The 10-year Treasury note rate, in turn, is driven by inflation expectations. On that front, rising inflation concerns are pushing 10-year treasury rates higher.
So what's the outlook for mortgage rates? The focus is shifting back to inflation, which means rates are unlikely to go much lower. But while inflation could pressure 10-year treasury rates, a narrowing risk premium could offset the impact on fixed-rate mortgages. In other words, odds favor rates moving higher, but not much higher, so anyone sitting on the sidelines waiting for a drastic improvement is likely waiting in vain.

Eric P. Egeland
RE/MAX United