Hawaii VA Loans

We have recently completed a three week stint where rates increased almost every day.  They have stabilized in the past week and even rebounded slightly, but that recent scare has everyone guessing where rates are headed next.  If you are anything like me, you have been hearing every possible scenario lately.  Of course, no one really knows what the real answer is, but we can do our best to analyze the reasons that each extreme could happen and hopefully define a reasonable expectation.

Let’s look at the rumor that we are all hoping for…will rates go down to 4.00%?  Unfortunately, I don’t think there’s much chance of that happening.  What brought the rates down to the low 4% range several months ago was the announcement and beginning of the Fed’s program of buying mortgages packaged by Fannie Mae and Freddie Mac (the majority of mortgages originated in the U.S.).  They are now about halfway through that program now and there isn’t much room for them to increase the amount of buying they can do.  Last week they announced that they will not be expanding that program.  They can no longer reduce the short term borrowing rates which are already at zero percent.

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This is a question that may have a surprising answer.  Many peoples’ first instinct is to conclude that if prices are falling, it would be smarter to wait for your dream home to decline in price and to buy at a later date and lower price.  However, interest rates play a significant role in the home buying process and should also factor into the decision.

The truth is, interest rates are at historic lows and, as the graph shows, have not been lower in at least 45 years.   The government has pledged to buy mortgages to help keep rates low, and they have done a great job keeping interest rates between 4.50% and 5.00% over the past few months.   However, the government’s help won’t last forever and investors will need the higher returns they’ve demanded in the past.   Without that support, interest rates would likely be significantly higher right now.  With rates so low and the government intervention fully priced into the market, there is a greater likelihood that they will move up not down.

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“What interest rate can you offer me?”  Ask any mortgage loan officer and they will tell you that this is probably the first and most commonly asked question they get from their customers.  Rightfully so, since the interest rate determines what your mortgage payment will be and, of course, we all want the lowest payment possible.

Now, this is a loaded question because one’s interest rate depends on many factors like down payment, equity in the home, credit score, property type and when you actually lock in the rate (here’s an old post we wrote on what determines mortgage rates).  Another important factor is the type of loan program you are using - a Conforming loan (a mortgage which the meets the underwriting requirements of Fannie Mae or Freddie Mac - and is most likely sold to them) or a Government loan (mortgage guaranteed by the government, most typically an FHA or VA loan).

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This is an age old question and actually quite complicated one (ok, maybe not quite age old, but common questions nonetheless). However, I will do my best to answer it as simply and accurately as possible. This is a slight oversimplification and this explanation may not apply to all mortgage rates, but it is the driving force behind the majority of rates (there are some lenders who set rates completely at their choosing, i.e credit unions, but they often base their rates off of other lenders’ rates which are described here). So, here it goes…

Mortgage rates, like stock prices are set by the open market. What does that mean? Well, it means that there isn’t someone sitting in a back room in Washington telling people what the rates are going to be. There are thousands of investors (mostly large banks, insurance companies and others) that buy and sell mortgage ‘securities’ every second the market is open. Whenever two agree on a price, that is the new market price. So…what are these securities? Lenders across the country sell individual loans to Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac, in turn give them back a security equal to the amount of loans sold to them. They also provide a guaranty that the principal (or the face value) of the security will be repaid. Because of this guaranty from Fannie Mae or Freddie Mac, investors are willing to buy these securities because they are now considered a safe investment. The buyer of the security does not need to worry if Joe in Detroit loses his job at the auto plant. Fannie and Freddie do that worrying for them and absorb any losses (I may describe that process in another blog post, but you’ve got enough to absorb within this one).

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