Monday, May 24, 2010

Chaos in Europe = Low Mortgage Rates for Americans

Stock market turmoil and chaos in Europe are helping Americans get low interest rates on their mortgages. How and why is this happening?

Flight to Quality
Over the past several months, expectations have been for higher interest rates. The end of the Federal Reserve’s $1.25 trillion mortgage-backed security purchase program suggested that rates would have to rise to attract more investors to purchase mortgages. But with all of the chaos in Europe, investors from around the globe are flocking to American bonds, including mortgage-backed securities.

The financial instability is not contained to just Greece. One of Spain’s largest banks, CajaSur, failed and had to be taken over by the Bank of Spain (Spain’s central bank). This news feeds the flight to quality by investors.

U.S. Treasuries and other “safe,” fixed-income investments are the beneficiaries. Mortgage-backed securities are included in the “safe” category because they have real collateral in the form of real estate. Real estate values have already taken major price hits over the past few years, and the worst of the devaluation appears to be over. In addition, underwriting standards are much more stringent than they were a few years ago, so investors understand that owning mortgages today is a sound investment.

Opportunities for Homeowners
The low fixed interest rates today represent opportunities for homeowners to refinance and lock in a low, fixed payment. In general, a 1% reduction in rate represents a 10% reduction in payment. Reducing a payment isn’t the only benefit. Some homeowners are choosing to shorten the term of their mortgage from 30 years to 15 years so that they can own their home “free and clear” sooner, and reduce the amount of interest they pay over the life of their mortgage.

Long Term View on Interest Rates

In the long run there are some factors that do not bode well for interest rates. Most notable is the growing federal deficit. In the first 220 years of recorded financial records of the United States (i.e., 1789-2008), the nation had cumulative deficits of $5.3 trillion (i.e., outlays in excess of receipts). The combined deficits in the 3 years of 2009-10-11 (i.e., the actual deficit of $1.4 trillion in 2009 plus the government's projected deficits in 2010 and 2011) are estimated to reach $4.2 trillion (source: White House, 5/10).

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