Interest Rates & Mortgage Update

The mortgage market continues to adjust to the turmoil in the credit markets. The trouble lies in the secondary mortgage market, where institutional investors purchase mortgage loans typically bundled into Mortgage Backed Securities. The yield that these investors demand is a function of perceived risk (how safe is the investment) and the typical concerns of long term bond investors, namely the threat of inflation over the long run. When the sub-prime crisis hit in July of last year, it dramatically changed the perceived risk of mortgage instruments in the secondary market. In other words, investors in the secondary market perceived a higher level of risk for mortgage loans in general, and either demanded more yield to compensate for this additional risk, or elected not to invest in mortgage instruments all together. This put immediate upward pressure on rates, especially jumbo mortgage loans (loans over $417,000).

Today, the climate is still difficult. The government has enacted legislation to raise the Fannie Mae conforming loan limits to $729,000 in our area. The hope was that this would help stabilize the mortgage rate environment and make homes more affordable in high price areas. Fannie Mae & Freddie Mac are considered to be backed by government, therefore they are perceived to be less risky than jumbo loans. Most mortgage experts thought that loans up to $729,000 would be at the lower conforming loan rates, which would be a boost to the real estate market. But unfortunately, the secondary market saw things a little differently. There are fewer buyers for the new conforming loans, and there is uncertainty on how to assess the risk, so as a result the yields are higher. (click on graph to enlarge)

Right now, loans over $417,000 up to $729,000 have around a 1/2% higher rate. Jumbo loans (over $729,000) have an additional premium of around 1/2% to 3/4% over those loans. So for fixed rate loans, current rates look like this: (note: this assumes a 0 point loan. No apr’s have been computed. Rates courtesy of Private Mortgage Advisors)

Conforming 30 year fixed up to $417,000 5.75%
Conforming 30 year fixed from $417,000 to $729,000 6.25%
Jumbo 30 year fixed loans over $729,000 7.0%

Now recently the Fed has been reducing their key short term interest rates in a bid to infuse capital into the economy. This has had some positive effect on rates in general, but it has also led to concerns about an increase in inflation, which can put upward pressure on long term rates. But it certainly helped short term mortgage instruments, especially adjustables and home equity lines of credit, which dropped as well. However, lenders and investors recently have become very leery of these types of loans given the high level of defaults. So predictably, the rates on these loans have to be higher to justify the perceived risk, which means that they are not as attractive today. In fact, these short term interest only fixed loans are not much lower than fixed rate loans. (click on the graph to enlarge)

Here is a breakdown of current rates for short term loans:

5 year interest only fixed up to $417,000 5.625%
5 year interest only fixed from $417,000 to $729,000 6.0 %
5 year interest only fixed jumbo over $729,000 6.75%

7 year interest only fixed up to $417,000 5.625%
7 year interest only fixed from $417,000 to $729,000 7.25%
7 year interest only fixed jumbo over $729,000 6.875%

Lastly, lenders in general have tightened up considerably on the underwriting guidelines. Now lenders are looking closely at the buyer’s credit scores to judge their qualifications, and across the board lenders are demanding higher downpayments. If you are trying to obtain a loan over $729,000, lenders are now requiring 20% down. There is low downpayment money available under $729,000, including FHA loans, so downpayments are not as critical under this amount. The simple fact is that lenders are not willing to take chances with buyer’s qualifications, and will look at the buyer very carefully to make sure they are qualified. The days of easy money are over for the real estate market, and while it makes things harder for now, it is much healthier for the market in the long run. Once the secondary market stabilizes, we should see capital flow back into mortgage instruments, and rates will come down as a result.