What's Going to Happen to Mortgage Rates?

Predicting the future course of interest rates may be the world's most dangerous profession. Therefore, I'm not going to make a real prediction, but I will give you an analysis of some of the forces at work.

Over some defined period, the real return to investors and savers has to be some number larger than the rate of inflation. If the rate of inflation is 2.5 percent, and you can get a 4.5 percent yield on a CD, your real return is 2 percent.

We currently have very low interest rates. The yield on 1-year T-Bills is .31 percent, one-third of 1 percent. You have to go out to the 7 year notes to get to 3 percent. People who put their money in CDs find they are getting yields in the 1.5 to 2 percent range. That's not much of a real return, and if you were trying to live on your investment income, you would be hard pressed at those rates.

The reason rates are low are that Federal Reserve, which sets the discount rate, wants to keep rates low to help bootstrap us out of this recession. Imagine how much harder that would be if the prime rate were at 6 percent and mortgage rates were at 8 percent.

The other factor is that there is an incredible amount of money "on the sidelines" searching for a better return. Although there was recently an outflow into stocks as the Dow Jones Industrial Average topped 10,000 again, the amount of money in money market funds is $3.4 TRILLION. Whoa!  I don't write that word very often!

In addition to using these tools, the Federal Reserve pledged to help support the mortgage market by buying 1.25 trillion (there it is again; pretty soon we’ll be talking about REAL money) in mortgage-backed securities (MBS) and another $200 billion in debt issued by Fannie Mae and Freddie Mac. 

It may be largely for this reason that we have mortgage rates that are so attractively low. We also know  that the "private mortgage market" that previously financed loans in the jumbo market virtually dried up.  The Fed's announcement was made in November 2008, and we all know that mortgage rates tumbled shortly thereafter. Absent the actions of the Fed, mortgage rates would certainly be higher than they have been during the last year.

The Fed has bought about two-thirds of its commitment and seems poised to stretch out the program, but not increase the dollar amount, so as to facilitate a more orderly transition to a normal market. If they pull this off correctly, maybe we'll see some of that money flow out of money market funds to start purchasing the higher-yielding MBS.

If the transition to a more "market-based" market is not orderly, I can see rates moving up quickly. If I were thinking of doing anything in the mortgage market, whether buying or refinancing, I wouldn't wait, seriously.

You can view the Fed's announcement and analysis HERE.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower articles, Randy is a mortgage broker who has financed over $1 billion in properties. He writes about home buying and real estate finance topics for CreditBloggers.com.