Mortgage Rates Wilt in the Shadow of Cyprus

Mortgage rates receded this week, thanks to the Federal Reserve and a small, financially troubled island in the Mediterranean Sea.

The benchmark 30-year fixed-rate mortgage fell to 3.78% from 3.85%, according to the Bankrate.com national survey of large lenders. The mortgages in this week's survey had an average total of 0.37 discount and origination points. One year ago, the mortgage index stood at 4.29%; four weeks ago, it was 3.8%.

The benchmark 15-year fixed-rate mortgage fell to 2.97% from 3.03%. The benchmark 5/1 adjustable-rate mortgage fell to 2.71 from 2.82%.

The decline in rates is partially attributed to the panic that Cyprus caused among investors worldwide when the European Union proposed a tax on deposits to bail out the country's banks. The EU wanted Cyprus to charge a tax of 6.75% on bank deposits of less than 100,000 euros and 9.9% on larger deposits. The Cypriot parliament voted against the plan Tuesday, but investors remain nervous.

How a Tiny European Island Helped Borrowers in the US

Why does an island with a population of 1.1 million people matter to investors and to mortgage rates? Cyprus' economy isn't that important to investors, but the proposed tax on deposits concerns investors because of the fear that other European countries could consider a similar solution to their debt issues.

"This Cyprus situation kind of put renewed focus on the problems in Europe," says John Walsh, president of Total Mortgage Services in Milford, Conn.

Cyprus is the latest European country to ask for a bailout since the euro debt crisis started.

"Although it's a small country, it created a lot of fear, and fear drives markets," says Bob Moulton, president of Americana Mortgage in Manhasset, N.Y.

Fear and uncertainty about the global economy normally result in investors selling riskier assets to park their money in safer assets, such as U.S. Treasury bonds and mortgage-backed securities, Moulton explains. As the demand for these safer investments increases, the yields, or rate of return on them, tend to decline. Mortgage rates often follow the same direction of yields.

A borrower's best friend: The Fed

Refinancers and homebuyers should be grateful to Cyprus for its troubles and also thank the Fed for keeping mortgage rates artificially low for so long. On Wednesday, the Federal Open Market Committee wrapped up its two-day meeting and issued a statement saying it will continue to invest $85 billion per month in mortgage-backed securities and long-term Treasury bonds to keep rates low.

"Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative," the statement reads.

No Guarantee the Gift Will Keep on Giving

Regardless of the turbulence in Europe and the Fed's help, there's no guarantee mortgage rates will remain low much longer. Borrowers shouldn't gamble and wait for rates to drop further, mortgage analysts say, especially as the economy continues to show signs of recovery.

"A lot of speculation is turning to later this year and the exit strategy of the Fed; as economic conditions continue to improve, some are realizing they may need to hedge their bond bets should interest rates rise quickly," says Brett Sinnott, director of secondary marketing for CMG Mortgage in San Ramon, Calif.

The Fed stated it "will continue to take appropriate account of the likely efficacy and costs" of its bond purchases when determining the pace and size of bond-buying programs.

Once the purchases end, there's no doubt mortgage rates will shoot up, analysts say.

For now, borrowers still have some time.

"I think rates will stay stable for the next week or two, until the next black swan," Moulton says.