As of now, the housing market offers some of the lowest refinance rates ever. These exist due to a combination of the state of the world financial markets and due to the policies of the United States government. In this season of political change, though, there are a number of proposals and political realities that could change the atmosphere greatly for homeowners looking to replace their mortgage with a more attractive one.
The Abolition of Freddie Mac and Fannie Mae
Government-sponsored entities, frequently referred to as the “GSEs,” are currently responsible for 90 percent of the money that gets lent out as mortgages, based on an article in the New York Times. When a homeowner gets a mortgage, their lender sells the mortgage to Freddie or Fannie. Freddie or Fannie then package large blocks of mortgages into bonds, and sell the bonds on the global financial markets to investors. Since bonds issued by Freddie and Fannie carry an implicit guarantee from the U.S. Government, investors will buy them at low rates of interest, making it possible for mortgages to be made at very low rates.
Politicians ranging from Barack Obama on the left to Ron Paul on the right have called for the abolition of these organizations. The problem with them is that they expose the government to a great deal of risk, since the government is ultimately responsible to bail them out. In addition, their role in the market distorts the true market for mortgage debt. If their role is abolished or cut back, private mortgage lenders will make more, if not all, of the loans in the market. They will likely demand higher rates of return on safer investments, leading to more expensive refinances at less attractive terms.
The biggest threat to the refinance environment is, ironically enough, good news. Right now, mortgages are cheap because global investors are buying large quantities of U.S. Government debt at very low interest rates. In an uncertain global economy, “flight-to-quality” vehicles such as Treasury bonds or mortgage bonds, underwritten by Fannie and Freddie and backed by the Treasury, become desirable not because of their returns but because investors who buy them know that there is an infinitesimally small risk that they will lose their money.
If the United States government figures out a way to generate a higher degree of growth, the economy will start to meaningfully recover. When this happens, the Federal Reserve will have to raise interest rates to avoid inflation. In addition, investors will become less interested in “safe” investments, and will buy more stocks, corporate bonds and other such vehicles. Reduced demand for government-backed mortgage securities will cause their interest rates to rise, increasing the rates that mortgage holders have to pay on purchase or refinance loans.
Eliminating the Mortgage Interest Deduction
Although politicians are generally loathe to discuss this possibility in an election year, the idea has been bandied around enough that it may very well return after the election. If it does, although it should have a negative effect on home values, it will likely be good for refinance rates.
Right now, when a person buys a home, they get a portion of their mortgage payment back in the form of reduced tax liability. For instance, a $250,000 home with a five-percent interest 30-year mortgage for $200,000 carries $9,933 in interest payments in the first year, with the amount of interest gradually going down as more principal gets paid off over the 30 years. If the homeowner’s combined federal and state taxes add up to 30 percent, they would save almost $3,000 in taxes.
Eliminating the deduction would increase the relative cost of owning a house. According to The Urban Institute’s paper “Reforming the Mortgage Interest Deduction,” this could shave ten percent off of a home’s value. Other impacts, though, could be to simply reduce the number of people who choose to buy homes, or to reduce the size of homes that people buy. In either instance, this would lead to a reduction in demand for mortgages, likely helping to keep both purchase and refinance rates low.
This is a guest post provided by Refinance Mortgage Rates, an organization focused on educating consumers on the current mortgage climate.