On the Fence About Refinancing?

After 24 years in the mortgage business, one thing is clear to me: Calling the bottom of a cyclical interest rate cycle is every bit as elusive as finding the top of a bull stock market. A few people manage to do it, but that’s mostly luck. The rest of us lesser mortals will manage to miss the boat… again.

I do have one prediction about the current interest rate environment:
The Federal Reserve will lower short term interest rates again. But what many people don’t understand is that the Fed has little control over longer term mortgage interest rates.

In fact, that’s one of my customers’ biggest misconceptions. They hear the Fed is lowering interest rates again and assume mortgage rates drop. In my experience, there is little correlation and mortgage rates often move in the opposite direction than the latest Fed action.

Here’s the deal: Mortgage rates for fixed rate loans, as well as adjustable rates with intro periods of five years or longer usually move in the same direction as the yield on the ten year Treasury note. That interest rate is controlled solely by expectations of inflation and inflation is a word we will be hearing a lot of in 2008.

Oil prices hit an inflation-adjusted all-time high just last month. And of course, the United States of America is the world’s largest consumer of that commodity. Many other commodities have hit new highs recently, and prices for virtually everything, from bread to tennis shoes are rising accordingly. Unfortunately, this outlook is not good for mortgage rates. Another dreaded word in the economic lexicon is popping up a lot these days: “recession”. Usually this bodes well for mortgage rates, but not always.

Typically, when our economy enters a recession (two consecutive quarters of negative economic growth), Americans tighten there belts and quit spending money so quickly. They drive less, eat out less, make due with their old TVs and put off buying a new washing machine for as long as possible. In order to move merchandise, retailers lower prices, and if we still won’t spend, start closing their doors and laying off staff. Unemployment goes up and people keep their wallets under lock and key. Eventually, the price of many goods begins to decline, including that ever so important commodity, oil.

When this happens, expectations for inflation tend to drop, bringing 10 year treasury rates lower and usually mortgage rates with them.

That’s not happening now.

The current credit crisis has really exacerbated the situation. This debacle is causing mortgage rates to actually move in the opposite direction of the ten year Treasury yield. This is a clear sign that banks are under tremendous pressure to fix their problem loans. The usual buyers of mortgage backed securities are shunning those bonds, further hurting the liquidity in the mortgage market. Normally, I would say we need “worse than expected” news to truly see a meaningful drop in longer term mortgage rates, but in today’s market, I am not so sure.

So where does this leave the fence sitter?

If you can clearly secure a lower interest rate in a similar product, it may be time to get off the fence. A good mortgage professional can easily analyze your situation and determine how soon your savings will pay for the cost of refinancing.

If you are in a low adjustable rate mortgage which is changing in the next six months, you should likely get your financial information to your mortgage professional. Having a full file ready to deliver to a bank will put you in a good position should interest rates make a meaningful move in either direction over the next few months.

If you are in a low adjustable rate mortgage which is changing in the next 6 to 36 months, you should really analyze your situation. The fence may feel like a good place right now, but you should clearly outline your goals as well as your risk tolerance as the market could be in a much different place in the near future. Do you intend to move in the next three years? Will you be doing a major addition to your home? Do you have a child who is going off to college? Will you be changing jobs? Are you expecting a monetary windfall? These are all questions that could affect how you structure your mortgage today. A conversation with a trusted advisor is definitely in order. Just to be clear, getting off the fence in this case may mean doing nothing to restructure your debt.

Tim Sickinger, Principal
Hamilton Ladd