Falling Interest Rates and Your Mortgage

Well, I've been so busy recently that I haven't posted. December often seems to be the busiest time of year -- and now it's time to do taxes.

I hope readers were able to take steps in advance, to profit from the lower interest rates as outlined in the last post. The economy and markets are weaker than most people expected, and the Fed has decided they'd better come to the rescue with aggressive rate cuts. Even with the two recent cuts totalling 125 basis points (1.25 percentage points), it's quite possible they will cut again at their next meeting in late March.

Although the economy won't really feel the effects of rate cuts for a few months, it's already helping some people as they rush to refinance their mortgages. It's helping others who have adjustable-rate mortgages because their rates won't adjust as high as they otherwise would.

By the way, I hope everyone has learned the lesson: When interest rates are low, it's not time to get an adjustable-rate mortgage. (In which direction do you think those low rates are gonna adjust?!) Even if rates are fairly high, it's a risk, and not to be taken lightly. Don't stretch to buy more house than you can afford, don't finance 90% or 100% of the house value, and make sure your mortagage doesn't have a prepayment penalty. Don't even buy a house unless you have a good emergency cash fund. These rules are basic, yet an enormous number of homeowners ignored them -- and are now paying the price. We all are paying with them, as neighborhoods become saturated with foreclosures, lenders become reluctant to make new loans, and the economy slows.

In other words, there's a lot to be said for the traditional fixed-rate mortgage. As interest rates fall, get ready to refinance if you can get a better rate, or if you currently have an adjustable rate.

Next time: Is it time to refinance right now?

The Mortgage Crisis, Part 3 - Can you take advantage?

Because of all the bad loans, which have created ripple effects through the real estate, banking, and homebuilding/home improvement industries, the economy is undeniably slowing, and it could result in a recession in 2008. However, most of my sources say we will probably escape without one.

The reasons? I can think of a couple offhand: Vigorous exports, helped by the falling value of the U.S. dollar; and lower interest rates.

A lot of people ary saying "No bailouts" and "let the chips fall where they may -- let the stupid borrowers be foreclosed on, let the stupid lenders go out of business, and let the stupid investors lose their shirts." The problem with that is, it's affecting the entire economy, in a snowballing effect. The Federal Reserve took basically that approach in 1929-1930, refusing to lower interest rates or engineer massive bailouts, until the it was too late and the Great Depression was irreversible. Federal Reserve chairman Ben Bernanke has made a career-long study of this sad episode in American economic history, and is determined not to repeat it.

My sources indicate that this is affecting the economy enough that the Federal Reserve isn't finished cutting interest rates. By now, just about everyone expects they will cut at least .25% next week. And in fact, many are saying they could cut by .50% (although that's somewhat less likely after today's fairly decent employment report).

Next year it's likely we'll see additional rate cuts. For instance, see this article.

Lower interest rates will not only stimulate the general economy, but it will also help these adjustable-rate mortgages not to adjust quite so much, and help borrowers refinance at better rates. You've heard on the news that there are agreements for lenders to freeze some of these existing interest rates for a while. It appears more agreements are also coming. This will give the Federal Reserve some more breathing room and time to lower rates enough to make more of a difference.

How do you take advantage of this?

• Consider moving some of your "safe money" out of money market accounts and into CDs that lock in your interest rate for a year or two, maybe more.



• Consider postponing refinancing your mortgage for several months, anticipating lower rates.



• As always, wait till June to decide whether or not to consolidate student loans (because you can only do it once, unless you have a new loan to include in the consolidation). Then you'll know what the new (lower) interest rate is, and you'll have a better idea whether or not they might continue even lower -- and then you can still wait till the following June to repeat the process.



• Consider buying long-term Treasury bonds, whose price will rise as interest rates fall. Actually this would have been a lot better to do in June, because they've been rising ever since then. But if rates keep falling, you should still get some benefit.



• Lower interest rates will also help the U.S. dollar continue its downward move. To take advantage of the declining dollar, invest in companies doing a lot of business overseas -- or invest in the overseas companies themselves.



• Combining the prior two ideas, consider investing in foreign bonds (denominated in strong currencies such as the Euro).

The Mortgage Crisis, Part 2

Because all the mortgage lenders could easily sell the loans to other investors, often packaged up with many other loans, they had plenty of incentives to drum up more and more business. Any time you have this situation, people tend to abuse it. How do you offset that?

A savvy consumer should partly offset it; if it's too expensive he theoretically doesn't buy. That didn't happen, partly because the borrowers also had a strong desire to buy property they could not in reality afford. Home ownership is, after all, the American Dream.

The credit rating agencies should partly offset it. They're supposed to be the ones that protect the buyers, valuing the loans properly (i.e., more risky therefore less valuable). Lower value on the loans means less incentive for the lenders to cheat. They could have stopped this thing cold if they rated the loans properly.

Of course since at least some lenders were fabricating income numbers, the rating agencies may not have had the ability to catch all those problems.

All in all, a bunch of lawyers are probably salivating over the prospects. Some of the lenders are bankrupt, others are on thin ice, so the ratings services with deep pockets ought to be getting uncomfortable about now.

It's also interesting to note that surely the top executives of lenders knew interest rates were going up and would continue to do so for a long time -- but the borrowers didn't. As far as they knew, rates could go either up or down. Oops.

The solution? Complex and in dispute. Some say the borrowers were stupid and should pay the price, emphasizing personal responsibility. Others say the lenders misled the borrowers and they have responsibility. Still others say the ones buying the loans are rich and can pay the price, and so on. As usual in a situation with so many moving parts, the answer is probably a mix of the above.

As a part of the solution, I favor allowing the borrowers to renegotiate at a lower (fixed) rate. (The Federal Reserve has already made this course of action more reasonable by cutting overall rates.) Of course this means the value of those loans would drop, but surely it would be less than the loss due to nonpayment and foreclosure. And the amount of the loss would be predictable -- not like the panic we've see this year. There's a saying that Wall Street can price in anything but uncertainty.

The Mortgage Crisis, Part 1

I happened to see that last Friday's episode of the "Now" program on PBS had a segment on the mortgage crisis. Normally this program is far too liberal for me, but I decided to see what they had to say. Here are a few notes:

• Potential loan losses of $400 billion, twice the S&L crisis, before this is done. (Although I presume this is not adjusted for inflation. A wild guess would be prices have doubled since then, so in that case these losses would be equal to the S&L crisis.)



• Housing prices projected to drop an aggregate $2 trillion across the nation.



• It was reported Countrywide sales reps made up income numbers to help close loans. They often didn't even ask the borrower what his income was.



• An ex-Ameriquest sales rep said they routinely forged documents to inflate income. They were told "say anything, do anything, to get the sale."



• Borrowers were told they could refinance before the rates went up, but when that time came, something prevented them -- such as high prepayment penalties, falling property value, a blotch on the borrower's credit record, etc.



• Lenders would not negotiate payments -- not accepting, for instance, a series of payments throughout the month which would equal the payment that had been due at the first of the month. (Of course they don't have to, but hey, it would be better than foreclosure. I'm reminded of Biff knocking on George McFly's head in "Back to the Future," saying "Hello, anybody home in there?")

My take on this is there's blame to go around. Some or many lenders played fast and loose, the investors bought the repackaged loans without sufficient due diligence, the credit rating agencies assured the buyers the loan packages were safe, and the consumers didn't pay enough attention and didn't do budgeting. Many violated the precept of not signing anything you don't read and understand, and many violated the precepts of having a good-size emergency fund, and not putting yourself out on a high-risk limb.

Many borrowers also had inferior credit (the very definition of "sub-prime"), without which they wouldn't have been going to these lenders and paying elevated interest rates in the first place. And that doesn't speak well of their native financial management skills, does it?

This shows the necessity of being financially well-informed, and conservative (even reluctant) when taking on debt. It's been commented that many people spend more time analyzing the purchase of a wide-screen TV than their mortgage, when the latter is far more important. If you don't do your homework the result is all too predictable.