The United States economy has had a seemingly endless stream of good news lately. Among the headlines have been the largest housing price gains in seven years (although housing prices are still far below their peak), the Dow and other indexes are posting some of their highs closes in years and there are glimmers of good news on the employment front. The town of Vail is setting sales tax revenue records as well and our local real estate market is recovering nicely. There is not much concern about a European debt crisis either (although that may or may not be over). The European recession threat is still there and that may be the biggest concern, although for the moment that is part of what is fueling the U.S. stock rally.
And with good news comes higher treasury bond yields. And following that, at least once the Fed stops feeding cash to the markets, will come higher mortgage backed bonds yield. As mortgage backed bonds are where mortgage money comes from, that means higher mortgage rates.
In times of economic uncertainty, investors tend to favor bonds over stocks, which drove the 10-year T-bill yield to hold in the mid 1 percent range the last few years. Recently, it has gone above 2 percent. This contradicts some economists who at the darkest hour predicted the 10-year might go to 1 percent as investors feared more for the return of their money than the return on their money.
In normal economic times this would mean the mortgage rates would have followed and gone up 1⁄2 percent as well. But these times are anything but normal.
The Federal Reserve has intervened in the markets, buying as much as $20 billion a week, primarily in mortgage backed securities. This river of cash has kept mortgage rates tamped down, and whether you like the concept or not, has been one of the most stabilizing factors in getting the economy rolling again.
I may get the evil eye from a few Republicans out there, but there are actually more than a few redeeming features about having the Feds support the housing sector. And I would note quite a few Republicans have been more than happy to have their mortgage payments slashed right along with their arch enemy Democrats.
But eventually the bar closes and the party is over, and my feeling is that we might have six months left before the Fed tires of manipulating the markets and gradually gets back to letting the free market rip. Less money flowing into bonds means less demand, which means that yields will rise to attract new investors.
I don't think we will see rates zoom back to 6 or 7 percent anytime this year, but we might see rates go up into the 4 percent range by the end of the year. What that means is that a $400,000 mortgage that was at 3.5 percent and cost $1,796 per month for principal and interest payments might cost $1,938 per month at 4.125 percent interest.
But before you decide the end of the world is near if we go to 4.125 precent, keep in mind that it was only five or six years ago that 6 percent was considered progress, and for much of the last 20 years we saw rates in the 7-8 percent range. A $400,000 loan at 8 percent would cost $2,935 per month, or $1,139 percent a month more than 3.5 percent.
And for all you young people out there (or if you're old enough that your memory is going) back in the early 1980s we briefly saw rates of 18%, which would make that $400,000 loan payment $6,028 per month (which is why there was not much real estate moving in 1981). Although the period was brief, it happened to be exactly the month that I had to refinance a construction loan into a permanent loan, and I lived with a 18 percent rate and somehow am still standing. In those days ,we dreamed of the day things would get back to single digits.
So the moral of this story is do not become complacent that rates will stay low forever, and expect to see higher rates by the fourth quarter of this year.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and can be reached at 970-748-0342. He welcomes mortgage-related inquiries from readers.