Chicken Little Has Come Out and Said the Sky is Falling!

February 22, 2010


The sky is falling?

The sky is falling?

Between the Fed’s FOMC minutes from its last meeting and the raise in the discount rate on Friday, prices in the mortgage-backed securities market have decreased by 1% and many banks have raised their 30-year fixed rate mortgage rate by .125% to .250%.

Is the Sky Falling?

Does this mean that rates are heading to the moon? Do you need to drop everything and refinance your home or purchase a new home right now? Have you lost out on the low rates that many borrowers and new home buyers have enjoyed for so many months.

The short answer is “No”….at least in the near term. There is no need to panic. The minutes of the FOMC meeting had a lot of back and forth on when and how the Fed will sell $1.25 trillion of mortgage-backed securities. If the Fed were to dump all of these securities today, it would raise the rates on new mortgage-backed securities because there would be more securities than investors. Rates of new mortgages would rise because most home mortgages in the US are funded by mortgage-backed securities. It is simple supply and demand.

But the Fed is not going to dump $1.25 trillion of securities. The Fed is slowly going to begin selling these securities, and there may be no additive change in rates. In fact, the Fed has been talking about this for so long that some of the change in rates is already priced into the market. Just the same, investors felt shocked and mortgage-backed prices went down by 0.28%.

What is the Impact of the Discount Rate Increase?

Well, what about the Fed raising the discount rate by 0.25%? Quite honestly, the Fed has been talking about eventually raising rates for months. This is not a surprise, but that does not stop the markets from over-reacting which drove down the price of mortgages by 0.68%.

But investors do that. The mortgage-backed market, like any market, is driven by fear as much as any other market (see stock market in 2008). No matter how many times the Fed indicated that it had to start raising rates at some point, investors and traders always like to show their shock, which causes prices to drop. Banks are still getting their bearings so when the prices in the mortgage-backed market go down, banks raise their mortgage rates to consumers by 0.125% to 0.250% to cover their market risk. Just because the Fed said it would happen, does not mean that people don’t panic when it does happen.

Rates Are Still at Historic Lows

So what does this mean? Well, in the short term, nothing! Mortgage rates are still at historical lows. There is no reason to panic. Even if rates on 30-year fixed rate mortgages rose by 0.50% to 1.00%, it is still a pretty good deal versus historical rates.

Whatever you do, do not panic! If you were thinking about refinancing, then you should probably start looking for a lender. If you are looking at buying a home and you think your personal finances can handle a mortgage payment, then now is a good time. If you need another 6 months to shape up your credit score and save some money for a down payment, you have time to do it.

Do Not Panic, But 5% Mortgage Rates Won’t Last Forever

There is no reason to panic, but keep in mind that the trend for rates is going to be toward the upside. The Fed began raising rates to signal to the markets that the gradual tightening of credit has to begin at some time. This raising of rates and selling of securities has to begin. Rates will go up. Not today, but within a reasonable time frame.

We cannot count on 5% mortgage rates forever. This is something you have to realize. There is no reason to panic and jump in with a new home purchase, but you will not have forever to enjoy this rate climate.

We’d like to thank damonj74 for kindly sharing today’s photo via the Creative Commons’ License.

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About Jim Pomposelli

After 12 years in investment banking in the mortgage-backed securities markets, Jim?s expertise in how the capital markets function and impact the pricing and structure of home loans is a unique competitive advantage. More importantly, Jim?s 12 years of experience working with Fortune 500 companies at JP Morgan and Bank One ensures a dedication to ethical responsibility, a high level of attention to detail and a dedicated approach to client service. Jim is also a true entrepreneur who has started two early stage companies. As an Eagle Scout, Jim is an active member of his community as a leader of a 170 family Cub Scout group and has volunteered for his alma mater, Georgetown University, for 19 years. An active member of the business community, Jim also belongs to the Lincoln Park Chamber of Commerce, Lakeview Chamber and the Chicago Realtors Associations. You can follow Jim on Facebook, Linkedin, Twitter, or his blog

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