Goodbye to Low Interest Mortgages

for saleIt hasn’t hit the mainstream media yet, but there’s plenty of discussion in financial news publications: there has been a sudden increase in the cost of housing loans. The cause is last week’s speech by Fed Chairman Ben Bernanke hinting at the possibility that that the Bank will start to taper off it’s program for buying mortgage backed securities sooner than the market expected. This caused a larger than expected reaction in the markets, with a sudden rise in interest rates.

For the average person, this is a bit of conflicting news. The Fed initiated their buying program -called QE3- as a way to stimulate the economy, and contribute to reducing unemployment. That they are considering to bring an end to the program is a strong signal that the economy is improving, and that in the near future they expect unemployment to drop below 7% -the target rate at which the Fed would stop it’s bond purchasing. That’s the good news.

The bad news is that you might have to pay more for a mortgage. The change in interest rates will not effect people who already have fixed rate mortgages (FRM); so if that’s your case, you can stop reading and go off to celebrate the good news for the American economy in your own way.

But if you have an Adjusted Rate Mortgage (ARM), or are thinking of getting a mortgage, then … please don’t shoot the messenger. Fed officials are doing all they can to reassure the market and keep interest rates from spiking. But the reality is that interest rates, especially for mortgages, have been uncommonly low. This has been deliberate to help out the housing market. But as the price of homes begins to increase and unemployment comes down, the Fed has to bring interest rates back to sustainable rates.

If you’ve had an ARM until now, try to feel happy about having lower interest payments over the last few years. Understanding a bit of how the market thinks will help you make a better decision about what to do next.

You see, traditionally when the Fed starts to cut back on what are called “accommodative measures”, which you will probably understand as “stimulus”, interest rates start to rise as the economy recovers and starts to grow. And they don’t go down until the next recession. Following standard trends, if this is in fact a full economic recovery, then it will be years before the next recession. In other words, interest rates will continue to rise for the foreseeable future -according to the markets. Because that means it will cost more in the future for banks to borrow money, they are preemptively raising interest rates on long-term loans (mortgages).

Banks are nice like that.

Banks are nice like that.

Specifically, what banks are worried about is that when people get wind of the rising interest rates, they will switch from their current ARM (the interest of which will increase over time) to a FRM (where the interest rate stays constant). It makes sense; interest rates could rise as much as 5 percentage points over the next few years, but the difference between an ARM and FRM now is just 0.5%. Sure, you’ll pay a little more for the next few months, but will save in the long run.

That’s if the markets are, for once, making an accurate evaluation of the future. Just because the Fed thinks the economy is improving doesn’t mean it will; it’s not like they saw the recession coming in the first place -or that it would be this bad. No one can predict the future. But it is a good time to sit down and think about your mortgage and what your best options are.

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