Mortgage refinancing: Wait or more on?
With the Federal Reserve buying billions of dollars worth of mortgage-backed securities, you might think that mortgage rates are poised to fall even lower than the current rock-bottom levels. Maybe you should wait on that refinancing, you wonder, or delay purchasing a house until the market is even more favorable.
Not so fast. The Fed's purchase program certainly is expected to keep rates low for some time, but there's no reason to think rates will fall much further, according to economists. In fact, looking at the past two Fed bond-buying programs, the market felt a stronger impact in the weeks immediately following the announcement - less so as time went by.
That's not to say that the Fed's actions are immaterial to current and potential homeowners. Three key factors that affect housing values and mortgage rates include why the Fed decided to act, current real estate market conditions and what the future could hold, both for the level of rates and the capacity of the financial system to handle demand for mortgage applications.
'The Fed wanted to give as much juice as possible to a piece of the economy that was starting to show some life,' said Liz Ann Sonders, chief investment strategist for San Francisco-based Charles Schwab & Co. 'What is more important is the turn we've seen in prices.'
On Sept. 13, Fed Chairman Ben Bernanke announced that each month the Fed would buy as much as $40 billion of mortgage bonds to support the market and boost the economy, as well as $45 billion of Treasury securities. The central bank also promised to keep interest rates low through mid-2015, regardless of signs of economic recovery. That caused mortgage rates to fall to historic low levels.
'The Fed is saying, 'We stand ready to do what we have to do to keep long-term rates down,' ' said Bob Walters, chief economist at Quicken Loans in Detroit.
Investors face a long stretch ahead of low returns from such traditional financial instruments as bank deposits and bonds. The Fed's hope is that they'll be pushed into buying real estate and that this will further lift home prices, said Joseph Kalish, chief global macro strategist for Ned Davis Research, based in Venice, Fla.
'You're really coercing investors who are holding cash to get into something else,' Kalish said. 'What Bernanke is hoping for is that some of that money ends up in real estate … People are fed up with earning zero percent at the bank. They're buying up these foreclosed properties.'
About 11 million U.S. homeowners owe more on their mortgages than the home is worth, known as being 'underwater.' For every 5 percent increase in home prices, another 2 million properties rise 'above water.' So policymakers can be most effective in helping homeowners if they're able to encourage prices to climb, Kalish said.
The CoreLogic Home Price Index is up 2.5 percent from a year ago and the Federal Housing Finance Agency's purchase-only index reached its highest level in nearly two years, after growing 3.7 percent from last year - the fastest pace since September 2006, according to Kalish.
Indeed, the factor of home prices is key in understanding the Fed's action. As much as the Fed has done to keep rates low during the past few years, it couldn't overcome the fact that home prices were falling at double-digit rates. Now that National Association of Realtors data show home prices beginning to appreciate again, by as much as 10 percent, it's finally profitable to buy a house again, Sonders said.
'That is why housing is really starting to ramp,' she said. 'Stocks and homes are the two biggest components of net worth, and they both are firing.'
The Fed wanted to jump on the momentum of this new energy for the economy, in hopes of building on the new confidence that will need to continue if unemployment is to fall and healthy growth is to be restored. Residential investment has contributed to economic growth in each of the past five quarters, after six years of the economy getting little or nothing from housing, Kalish said.
'We think the housing market has hit bottom in terms of activity and pricing, and we're looking for these trends to continue for several years,' he said. 'It's about even between buyers and sellers; nobody has an advantage. This tighter market is helping to drive up prices. You hear [real estate agents] talking about a shortage of supply, even in Florida.'
As prices rise and more homeowners have positive equity, it could make it easier for banks to loosen credit standards and solve some of the problems borrowers have had with credit approval, too-low appraisals and difficulty with short sales, Walters said.
'A rising housing market starts to heal a lot of those things,' he said. 'We're seeing pretty significant evidence that housing has bottomed and is doing better than ever. It's going to start to resolve a lot of the challenges in the marketplace.'
Already, the Fed's bond purchase program has boosted the number of refinancing applications to the highest level since April 2009, adding to an existing backlog. For homeowners who have been waiting months for a refinancing to process, that delay is unlikely to change substantially until after the election. There's simply too much undecided about federal mortgage policy and the future of the budget and deficit debate, Kalish said.
'The banks can see this increase in demand, and it may warrant some additional hiring, but they're really reluctant to staff back up. They're under tremendous pressure with leverage and costs,' he said. 'They're going to be pretty cautious.'
Mortgage lending for home purchases is constrained even more, by a combination of borrowers' difficulty obtaining mortgage insurance, higher servicing costs, more conservative appraisals, smaller lender staffing and the macroeconomic uncertainty. Even borrowers who obtain a new mortgage should expect continued lengthy approval timelines, extensive documentation and higher costs.
'The real estate market is not a quick-fix market. It takes months to see changes,' Kalish said. 'The banks went through a horrific time the last few years so they don't want to take another risk with people with low FICO scores.'
That said, lenders will probably resume hiring in force after a sustained period of rising prices and solid demand. The Fed's support through its mortgage bond-buying program takes a big step in that direction.
'The Fed has proven it's going to do what it can, and what it wants is to keep long-term rates down,' Sonders said.
But Sonders, Walters and Kalish cautioned that individual homeowners shouldn't procrastinate on refinancing or purchase decisions just because rates should stay low for some time. Other factors, both personal finances and life stage, should be given greater weight.
'When rates move, they can move rapidly and they don't ring a bell when they're about to move,' Walters said.