Interest Rate News from HSH Associates

The following are excerpts from the newletter from HSH Associates for the week ending December 14, 2007:

The bond markets, after weeks of fretting that the economy would continue to sink, now seem to think that the economy might skirt a significant downturn after all. Of course, a more-firm economy brings potential for higher inflation pressures, and that in turn presses interest rates higher — and higher they are.

The pain was spread all around: fixed-rate conforming loans moved 19 basis points higher to 6.18%, while jumbos moved a full 21 basis points higher, climbing back over 7% for the first time since mid-October.

The Federal Reserve, in conjunction with 4 other European Central Banks have created a new credit facility for banks to borrow money. This move is important for mortgage borrowers since it’s directly aimed at lowering the rates being charged between banks on the London Exchange, called LIBOR. LIBOR rates have been mostly rising as banks have become concerned about keeping enough cash on hand to meet their needs and suspicious of the quality of assets being pledged as collateral for loans.

As we wrote last week, a borrower with a Treasury-based ARM is seeing interest rates reset to favorable levels. Presently, a borrower with a 3/1 TCM-based ARM has been enjoying an initial interest rate of about 4.75%, and six months ago would have faced a reset into the low 7% range. Fast forward through more troubled economic times, and add in cuts in short-term interest rates of 100 basis points (1%), and that borrower now may face a reset to only the upper 5% range for their ARM, with about a 12% rise in payment. That same borrower with a LIBOR-based ARM would see a reset rate at or about 7% or more today, with a corresponding 22% rise in payment, making a LIBOR-based ARM more likely to experience default. Since most subprime ARMs and many Jumbo ARMs are keyed to LIBOR, the central bank’s move to break the lending logjam should help to press those index rates downward. This in turn could make resetting mortgages more manageable for borrowers, and should help to ease the mortgage crisis a little.

With an economy holding on, concerns about inflation renewed, and potential ’solutions’ to mortgage and liquidity issues hitting the market, mortgage rates really don’t have much room to fall, absent any especially bad news.

Fed Cuts Short term Interest rate additional .25%

The Federal Reserve cut its fed funds rate by .25%, making the third consecutive monthly cut by the Fed since the credit crisis deepened in August. Although this decrease will help those homeowners who have home equity lines tied to short term interest rates such as the Prime Rate, these cuts in short term interest rates generally have an opposite effect on long term mortgage rates, which are much more affected by inflationary expectations. Aggressive cuts in short term interest rates are seen by most investors as stimulating inflationary pressures.

Several factors continue to impact the cost of home financing. Both Fannie Mae and Feddie Mac, the two large government sponsored morgage investors who purchase home loans after they are originated and thus provide on-going capital to fund new mortgages for loans with a limit of $417,000, have recently instituted a .25% up-front charge on all new mortgages that it buys or guarantees. On a $400,000 loan, this will increase closing costs by an extra $1,000.  Additional surcharges are also being charged borrowers with credit scores of less than 680, with some lenders even raising their level of what they consider to be good credit risks to 720.

People with good credit scores and an adequate down-payment can still get a “conforming” loan of up to $417,000 for approx. 6.14% (per HSH Associates), however the spread between the rates for conforming loans and jumbo loans (those in excess of $417,000) continues to widen, with borrowers with good credit and down payment are paying an average of 7.13%, a full percentage point higer than conforming loans. Normal spreads, before the credit crisis began, ranged to only 2/10th of 1%. 

This large spread recognizes that there is almost no market available to sell new jumbo loans to after they are originated as investors who used to invest in mortgage backed securites (pools of mortgages bundled together and sold to investors) have almost completely stopped investing in these securites. Because of this, there is a real shortage of capital available to make new jumbo loans. Most new jumbo loans are being made by investors who have capital available to hold these new mortgages in their own portgolios.

The interest rates quoted above are for what are called “full doc” loans, where the borrowers income can be fully documented, compared to “stated income” loans where the borrower simply attests to his income. Interest rates for “stated loans”, where available, can be up to an additional 8/10ths of 1%.

Money is available to credit worthy borrowers with down payments of 15 to 20%, and although more expensive than 6 months ago, rates are still at historically attractive levels.  Financing for borrowers with down payments of less than 15% is available, but will require more expensive mortgage insurance payments and higher interest rates.

As the credit crisis settles out, and investors become more comfortable that additonal large decrease in home values will take place, investors will once again begin to invest in mortgage backed securites, which should begin to reduce the spread between conforming loans and jumbo loans.