Mortgage Blog

Over the last six months the Federal Reserve has cut its Fed funds target rate by 3%. However during the same period the 30 year fixed rate mortgage has barely budged. As we discussed in a previous posting the Fed does not directly influence mortgage rates. Instead the financial markets set these rates usually by adding a “spread” over the 10 year US Treasury rate.

In normal times this spread between the 10 year treasury and the 30 year fixed ran around 1.3% but as a result of the credit crisis this gap has widened to almost 2.3%. For Jumbo mortgages, that is those with loan amounts above $417,000 (temporarily higher in some markets) the gap has become even wider. One year ago the typical difference between a conforming loan (below $417,000) and a non-conforming loan (above $417,000) was about 0.25%. Today it runs 1.5%.

The reason that mortgage rates have remained high is due to the credit crisis. Investors are fearful of the rising rate of delinquencies and foreclosures. In order to continue to entice investors to buy mortgage backed securities, Lenders are forced to keep rates artificially high.

In our next post we will deal with some other changes that are making mortgages even more expensive for some borrowers.

As if matters were not bad enough recent changes in guidelines by Fannie Mae and Freddie Mac has made mortgages even more expensive for many borrowers. Fannie Mae (FNMA) and Freddie Mac (FHLMC) are quasi government agencies, now publicly held, which purchase vast amounts of mortgages on the secondary market. Lenders sell their loans to these agencies in order to obtain new capital to lend.

Spooked by the recent credit crises both Fannie and Freddie have added pricing adjustments for certain types of mortgages. For example a borrower with a credit score of 680 and putting down 20% on a home purchase would need to pay one half point (0.5% of the loan amount) in order to obtain the same rate as a borrower with a score of 720 or higher. It gets even worse for borrowers with below average scores. A borrower with a score of 619 or lower would have to pay a whopping 2.75 points (2.75%) to get the best rate, even when putting down 20%.

In our view these changes represent a major overreaction on behalf of both FNMA and Freddie Mac. Unless and until these price adjustments are relaxed there is little prospect of an improvement in the housing and mortgage situation in America. The credit crunch runs a real danger of driving the US and World economies into a major recession or worse. Drastic action is needed if a complete collapse is to be avoided.