Mortgage Rate and Real Estate Update – Week of 12/17/12

Tired of hearing about the fiscal cliff and quantitative easing (QE)?   Me too.  However, there are some key things on the table in Congress that may affect the house that you own or are thinking about buying.

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Fiscal Cliff and the Impact on Mortgage Rates and Deductions

Another week has passed without resolution to the ‘fiscal cliff’ that is ahead of us.  In short, the ‘fiscal cliff’, a term coined by Fed Chief Bernanke, describes a massive shortfall in revenues (taxes) in comparison to the budget.  Last year, Congress spent $3.6 trillion and only brought in $2.3 trillion in revenue, a shortfall of over 56%.  If a family were to budget their finances in the same manner, they may have earned $100k in income for the year but ended up spending every dime they earned, saved zero dollars and would have racked up over $56,000 in additional credit card debt.  No bueno, especially when the spending has been that way for years and years.  Sorry U.S. government, no home loan for you!

So with a $1.3 trillion shortfall going forward, cuts must be made to the budget and tax revenues must be increased.  Easy targets could be things like Homeland security, Energy or the Interior budget (No, not home furnishing for the White House), but these items are so small and would only account for less than 2.5% of the overall budget.  The cuts will have to come from bigger components, things like Social Security, Health and Human Services, or Defense, each of which is held close to the heart of one of the powers in Congress, whether the Defense for the GOP or social programs for the Dems.  Therein lies the stalemate so far.  Two ways of thought and two ways of spending that must reach a common ground.

However, regardless of where the cuts come from, the Tax revenues will have to be increased.  One sure way will be to raise taxes for those considered to be the ‘wealthiest Americans’, but the definition of those ‘wealthiest Americans’  is vastly different between party lines.  Republicans have acknowledged these Americans to be earning $1 million and higher where the President stands behind his definition as those earning upwards of $250k.  Whatever the collective definition ends up becoming, there will be additional tax revenue to help reduce the shortfall.

Aside from tax hikes for the wealthy, additional revenues will likely come from the elimination of certain tax deductions.  The one near and dear to our hearts is the mortgage interest tax deduction, which currently allows owners of a primary residence to deduct the interest that they pay each year from their overall income, thus reducing their tax liability.  Millions of American families are able to apply this deduction to their taxes each year and save on average $5,459 on their tax bill.  Will this cause a slowdown for housing as home buyers see less incentive to buy instead of rent?

Other tax deduction caps are likely to come into the fold, possibly placing a cap on the total deductions that someone can take.  For most individuals, the caps will be a non-issue, but for self-employed and small business owners, the caps will change the way their businesses and accounting practices are structured.

The Fed Introduces More Easing to Keep Rates Low

Amidst the talks of the fiscal cliff, the Fed held is closed-door meetings last week and announced its Fed Policy Change on Wednesday 12/12/12.  Fed Chairman Bernanke announced that the Fed will begin spending an additional $45 billion per month, targeting longer term Treasury securities, replacing ‘Operation Twist’ which expires at year-end.  The big twist came when the Fed decided to no longer use a specific timetable to indicate an end to the monetary policy.  Instead the Fed has decided that they will not start tightening monetary policy until unemployment hits 6.5% and/or inflation between 1 and 2 years ahead is projected to be no more than one half percentage point above the committee’s 2% threshold and longer term inflation figures continue to be well anchored.  The good news is that this shift in policy now allows the markets to make their own projections about when these thresholds will be reached and can adjust their trading and investment strategies accordingly.

The Fed’s Monetary Policy and How it Can Impact Mortgage Rates

Fed Chairman Bernanke announced that the Fed will continue their threshold to spend $40 billion per month targeting Mortgage Backed Securities, reiterating the early message that improvement in the housing market through a low-rate environment will be most effective path to improve the economy.  The big change comes in the decision to start changing monetary policy (heavily through interest rates) once inflation is projected to be 2.5% or higher over the next 1 or 2 years.  Since inflation has a direct relationship with mortgage interest rates, it’s highly probable that once projected inflation reaches/exceeds those levels, interest rates will go up.  The Fed will do all in its power to keep inflation with a target range.  How does the Fed control inflation?  They increase interest rates that they allow Banks to borrow money, which increases the rates that Banks have to charge to their clients.

Ahem… (raises hand).  Is it possible that all of the printing of money to be able to spend the $85 billion on mortgage and long term securities possible a risk for higher inflation and higher interest rates?

Fed’s likely response:  We have yet to be able to determine the efficacy of the quantitative easement.

Down the rabbit hole we go.  Let’s just go ahead and pretend that printing $1 trillion a year is a cause for higher inflation….just pretending though.

If the projected inflation triggers the Fed to change its monetary policy, the Fed would immediately start to increase interest rates as a way to combat inflationary pressures and reduce the supply of money in the market (make it cost more to borrow).  The end result is that the interest rates for consumers start to go up until the Fed sees inflation readings get back into the target range of 1.8% – 2%.  By that time, investors around the globe are starting say, “Wait a minute, you’ve sold me these securities on long-term mortgage and other things and they’re paying me a rate of return of 1.5%-2% but based on projected inflation, my dollar is going to be losing 3% or more per year?  So I’ll be losing money?  No thanks, I’m out.”

So what happens, investors sell their long-term securities and the only way to entice them back into the market is to….that’s right, Raise the rate or yield that they are receiving on that security.  In other words, we have to raise mortgage rates to a level that still gives investors a way to outpace inflation and make money.

The days of a 30 year fixed rate in the 3% – 4% range could be long gone, trending back to a level of normalcy of who knows, 6% or 7%?  Only time will tell.  Food for thought – if interest rates go up by one percent, a buyer looking in the $250,000 price range will have lost $30,000 in purchasing power.  If interest rates go up to 6% (last seen less than 5 years ago), the same budget would only allow a $175,000 loan amount.  That’s a difference of $75,000 in purchasing power.   It’s time to start thinking seriously about your home buying and/or home selling strategy.

Our Strategy for Home Loan Interest Rates Going Forward

Home loan rates continue to trade near historic lows and should continue to stay in its trading range for the coming weeks and possibly months.  At the same time, we do not see any reason that interest rates should get much lower than they are now, so if you are waiting around for a 2% rate on a 30 yr, we wish you the best of luck.  If it were me, I would take advantage of interest rates sooner rather than later. While the Fed maintains its goal of keeping home loan rates low for the foreseeable future, the Fed cannot control the entire market.  The $40 billion a month being used to target mortgage backed securities can help support the market, but overall market direction is based on many bigger picture items (ie.  inflation, strength of global economy, Credit ratings, etc.).

Historically, interest rates tend to be lower in the winter and creep higher during the peak home buying season in the spring and through summer.  We expect this trend to continue but will remain proactive with our clients and their home loan strategy.  If you’re happy with your home loan options, take them while you can.  Whether in 2013 or 2014, we are potentially only one bad inflation reading away from  higher interest rates.

We maintain an ongoing dialogue with our clients about the market and interest rates throughout their financing experience so we can take advantage of the lowest rates when they present themselves. We all want the lowest rate, and the best way to ensure that you get the lowest rate, is to build a relationship with your mortgage planner, so they can best advise you on when to lock in your rate. Call us today for a complimentary mortgage review or Apply Online.