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Good or Bad Thing? Rates Drop After S&P Downgrades Credit Rating

Written By:
August 19, 2011 at 3:36 PM

Borrowers are doing the “lock in limbo” again as mortgage rates continue to nosedive. Following the dark days of the S&P downgrade, 30-year fixed mortgage rates dropped from 4.39% the previous week to 4.32%. According to the Freddie Mac’s Primary Mortgage Market Survey, 15-year fixed mortgage rates actually set a new record for the second week in a row with rates down to 3.5%, dropping from 3.54% last week.

Borrowers are wondering--how low can they go? According to Dough Lebda, CEO of Lending Tree, “It’s a crazy time. I’d say rates can’t get much lower, but I was saying that last week too.”

For those locking in at the new low rate, the savings can be incredible. For example, a borrower with a $200,000, 30-year fixed loan could lock in at 4.32% and make a monthly payment of only $992, compared to the same amount and term at 5% where they would pay $1,074 a month.

Mortgage Rate Plunge Revved up the Refinance Train

Refinances are alive and well with total mortgage borrowing, mainly from refinances spiking at 22%. Greg McBride, chief economist at says, "Rates have been below 5.5% for two years. For most people who have refinanced or purchased since then, there's little benefit to refinancing. But when rates drop below 4.5%, then it's worth looking into."

According to market researcher CoreLogic, more than 63% of residential mortgages are tied to interest rates of 5% or higher. With rates well below 5%, many homeowners are looking to refinance to free up cash.

However, only 46% of homeowners with a mortgage only have equity of 20% or less in their homes, which makes refinancing difficult without mortgage insurance.

While lending standards continue to squeeze the average borrower, those who can refinance are going for the lower rates along with lower terms. During first quarter, Freddie Mac reports that 34% of those who refinanced paid off a 30-year mortgage loan and moved to a 20 or 15-year product.

Frank Nothaft, Freddie Mac chief economist says that we should expect to see a trend with this type of refinancing.

Less Mortgage Default as Market Gains Footing--But For How Long?

RealtyTrac, Inc. reports that fewer homeowners defaulted on their mortgage loan in July, with default notices falling 7% from the previous month. Overall this year, defaults are down 39% from last year.

Rick Sharga, senior vice president of RealtyTrac says that he wishes the news was due to an improving economy. "While it would be nice to report that foreclosure activity is dropping because of an improvement in the housing market or even in the overall economy, that’s simply not the case.”

One glimmer of hope however, may be the reduction in unemployment claims, which fell below 400,000 for the first time since April. Steven Wood, chief economist at Insight Economics says the data is encouraging, “Although the labor market also hit a ‘soft patch’ along with most of the rest of the economy during the spring and early summer, it now appears to be strengthening, at least a little, again.’’

However, with the job market showing signs of life, it may not be able to provide the housing market with enough buoyancy to maintain the low default rate. Although rates remain low, borrowing costs may rise due to the S&P downgrade.

Keith Gumbinger of HSH Associates expressed concern about the overall spread and where lending costs will fall.

"Low Treasury interest rates are still not being fully passed through to mortgage borrowers," he says. "That argues that mortgage rates could go lower. Will the spread shrink again, though? That's hard to say."

Any further decline could make borrowing more expensive for Freddie Mac and Fannie Mae, which means increased costs would be passed along directly to the borrower.

Additionally, people who invest in mortgage backed securities may get jittery and back away if rates drop even more. Gumbinger explains that the low rates would also give borrowers less incentive to prepay their mortgages, which would stick investors with a low ROI.

This could create a domino effect on the markets, however Gumbinger says that in order to prepare for risk, investors may demand greater yields, which would keep mortgage rates slightly higher--still within “a historically low range”





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