Expect the unexpected.
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That could almost be the year 2011's motto so far, and it may be as good a reason as any to believe that current mortgage rates won't stay below 5 percent, even though they've been at or around that level for the better part of two years now. Perhaps of even greater note, though, is that there are three more substantive reasons to expect mortgage rates to move higher:
- The end of Freddie and Fannie. There are many different views on how to reform mortgage finance companies Fannie Mae and Freddie Mac, but there is a growing consensus that allowing them to continue to operate as private, for-profit entities with a government safety net for their mistakes is a formula for disaster.
By helping to finance mortgages written by private lenders, Freddie and Fannie have made those lenders more willing to write mortgages. This is good to an extent, but having reached the point where both those lenders and Freddie and Fannie got careless about underwriting standards, it has become too expensive for the American taxpayer. It will take a long time to unwind Freddie and Fannie, but as reforms are put into place, expect lending standards to tighten, and mortgage rates to rise.
- Inflation is on the march. When 30-year mortgage rates first dropped below 5 percent, in April of 2009, year-over-year inflation was actually negative. Now inflation is over 2 percent, and rising. Meanwhile, current mortgage rates are still below 5 percent. Something's got to give, and it doesn't look like it's going to be inflation.
When inflation was negative, lenders could afford to drop mortgage rates below 5 percent because they weren't giving up any of that interest to inflation. In fact, when mortgage rates dropped to 4.81 percent in April of 2009, inflation was at -0.6 percent, so mortgage rates enjoyed a 5.41 percent cushion over inflation. This was actually higher than the long-term historical average cushion of 4.44 percent. By February of 2011, though, with mortgage rates at about the same level, the cushion over inflation has shrunk to 2.75 percent. Since inflation seems to be gathering steam, the natural response would be for mortgage rates to rise.
- History. Financial history does not always repeat itself in an orderly manner, but part of making responsible financial decisions is understanding what is normal and what is not. From a historical perspective, current mortgage rates are clearly not normal. 30-year mortgage rates have averaged 8.88 percent over time. They have been under 5 percent in just 17 of the 479 months on record - or about 3.5 percent of the time. Just a return to the lower 25th percentile of all-time mortgage rates would see 30-year rates rise to 6.92 percent.
None of the above should imply that you should buy a house if you didn't intend to or can't afford to. However, if you've been planning on it, or if you are in a position to refinance an existing mortgage, be advised that there are three good reasons to believe that delaying could cost you money.
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