What the Bailout Means for Mortgage Rates

With the housing-triggered credit crisis growing increasingly ugly, Washington is considering embarking on the most-sweeping bailout of the financial system since the Great Depression. Under the terms of the legislation—which still faces an uncertain road through Congress—the government would purchase up to $700 billion of souring mortgage securities and other assets from banks. The result, its supporters hope, would be to revive the credit markets and avoid broader damage to the economy. But what impact will this massive government intervention have on mortgage rates? To answer that question, U.S. News turned to Mike Larson, an analyst with Weiss Research. Excerpts:

What would the bailout plan do to mortgage-rate trends?
One of the goals of this plan is to calm the credit markets and narrow the "spread"—or difference—between mortgage rates and rates on risk-free treasuries. The Treasury Department's recent announcement that it would buy mortgage-backed securities in the open market is also designed to obtain the same results. But the problem is all these programs cost money. Lots of money.

It's not like we as a country have that money sitting in a bank somewhere. We're going to have to borrow it—or in other words, sell treasuries by the truckload. All else being equal, that large new wave of treasury supply should pressure treasury yields higher. So even if spreads tighten, rates on underlying treasuries should rise. The likely net result: Mortgage rates go up.

What's your outlook for fixed mortgage rates over the next six and 12 months?
A 30-year fixed-rate loan goes for about 6.09 percent, per the September 25th Freddie Mac weekly data. I don't believe rates will shoot up from here, but I do believe the trend will be gradually higher over the coming year. Six months from now, we could be looking at a rate in the mid-6s. A year down the road, maybe 7 percent.

How about the outlook for adjustable-rate mortgage products?
Rates on shorter-term ARMs track shorter-term yields. I simply cannot see the Federal Reserve hiking interest rates any time soon, given the problems in housing, the credit markets, and the economy as a whole. So someone taking out an ARM today probably isn't at much risk of his rate shooting up any time soon. But that depends on the index your ARM tracks. Some ARMs track Libor, rather than short-term Treasury yields, as their benchmark. Those benchmark Libor rates have been going haywire lately due to all the credit turmoil. Definitely check your paperwork to see if you are at risk.

Would you recommend consumers use adjustable-rate mortgage products?
I still believe the certainty of a fixed rate is a nice security blanket to have. And with fixed rates likely headed higher, I would advise mortgage hunters to go with the 30-year fixed.

If someone does have an adjustable-rate mortgage product, would this be a good time to try to refinance?
It can't hurt to run the numbers. While fixed rates are up a bit from their lows of a couple weeks ago, they really are cheap from a long-term perspective. So why not give yourself the certainty that comes with a 30-year fixed mortgage?

Given the ongoing credit crunch, how much more difficult will it be for consumers to obtain a fixed-rate home loan?
If you don't have great credit and some down-payment money, you're having a tough time these days. The subprime market is dead. The Alt-A market is all but gone. Conventional Fannie Mae/Freddie Mac loans—and the Federal Housing Administration—essentially ARE the mortgage market today. And, frankly, maybe that's a good thing. The lesson we should all take away from this mess is that homeownership is a privilege, not a right. It is something we should save for. Very large financial transactions just shouldn't be undertaken lightly. Buying a house with, say, no money down, a 500 FICO score, and a debt-to-income ratio of 50 percent just doesn't make sense for the long term.

What should consumers be doing now in order to ensure that they'll be in the best position to get the best rate possible?
Get your credit situation in order. Start saving up down-payment money. Do whatever you can to improve your borrower profile so that you can qualify for a traditional loan. Also, be realistic. In this current environment, you are going to pay more for jumbo financing. You're going to pay more if you're a nontraditional buyer. So go into any home-buying transaction with your eyes wide open, factoring in the increased financing costs when deciding if you can really afford that house or not.