Mortgage Rates are headed back up
By Scott Ramella - July 2004
Wow, has it really been 4 years since I wrote that first article? I actually got it right. 30 year fixed mortgage rates got down to almost 5 percent. That’s why I decided to add another little tale to our website. The same factors that were instrumental on lowering mortgage interest rates to the lowest levels in 40 years are now working to raise them.
Not to over simplify things, but the annual budget deficit and long term national debt are killers when it comes to fostering a low rate atmosphere. For much of the late 90’s, the economy was roaring, corporate growth was explosive, and for a short period of time, the United States was actually paying OFF it’s debt, not accumulating it.
What a difference a few years can make.
Thanks to tax cuts (which I happen to agree with) and a slowdown for the economy, we’re now due to wrack up almost $500 Billion in new debt for 2004. This is bad for mortgage rates. Very bad. Let me explain.
When the Federal Government is issuing that much new debt, selling hundreds of billions of dollars of new Treasuries, it places a strain on the lending market in general, but bonds in particular. We care about that because bond prices and rates are inextricably linked to interest rates and especially mortgage rates.
Bonds serve as something of a baseline. The United States, as a benchmark nation, sets the floor for mortgage rates. The government has not defaulted yet on its loans, so it’s considered the ultimate in safe investments.
Everything goes up from there. Say the 30 year US Bond is yielding 5%. One of the next safest loans is on a home, because the home itself secures the loan in case the borrower defaults. A home equity loan, car loans, secured loans, credit cards, etc. The more risk of default, the higher the risk premium built into the rate to compensate the lender for that risk.
Back to the subject at hand. When so much new debt is being issued, there is only so much that the market can absorb before it starts to ask for higher rates. When you have a choice from so many companies and governments issuing debt, you can pick and choose what bonds to buy, and the typical savvy investor will gravitate towards higher yields. So the more debt that is issued means in the long run that higher rates will prevail.
On top of this, with an economy waking from a prolonged slump, the Fed is forced to raise interest rates to keep inflation under control and to make sure growth doesn’t get crazy. So we’re now on the other end of a cycle. We’ll probably see long term interest rates rise back at least to the mid 7% range. Once the economy starts to cool, we’ll start it all over again. Of course, wars, oil prices, outsourcing, and terrorist attacks tend to affect the picture as well.
Hopefully, the federal tax cuts will create long term growth, higher tax revenue, and we’ll grow out of this current deficit period. If not, the ultra-low rates we’ve enjoyed for the past few years may be gone forever. Our ability or lack of conviction to make the difficult choices and handle the Baby Boomer/Social Security crisis will make the budget deficit look like child’s play in comparison.
Scott Ramella (SRamella@aol.com) is a licensed mortgage broker for the State of Florida, has a bachelor's degree in Finance, and has been actively involved in the mortgage business since 1995 in several capacities.
**None of the opinions stated here are meant to be construed as the opinion, in whole or in part, of MortgageRatesUSA.com**