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Influenced by Inflation, Mortgage Rate Has Little to do with Prime - 2008-03-30 |
Last week, I had the opportunity to visit with a group of prospective home buyers from the Emory Alliance Credit Union. I was surprised that we had such a good turnout when everybody seems to think that no one is in the market to buy a house.
Here are some of their questions:
Q: The prime interest rate has dropped by a full two percentage points since the first of this year. Why aren't home loan rates any lower than they are?
A: The prime interest rate gets a lot of news coverage, because it affects so many consumers that have credit card debt or home equity balances that are tied to the current prime rate. But in fact, the prime rate has little to do with long term home loans.
Currently, the Federal Reserve is using temporary cuts in the prime rate as a means of stimulating the economy and hopefully avoiding a recession. By lowering the prime rate, the central bank hopes to boost spending and investment, and maintain strong job growth. You might think of this action as a temporary shot in the arm of our economy.
However, the rates that investors are willing to accept for long term debt (such as 30 year home loans) is more often linked to the threat of long term inflation that these investors perceive over the next 10 years. That's why many economists look to the 10-year Treasury bond to help forecast home loan rates.
And while the short term stimulus of a prime rate cut may be appropriate for our current situation, many feel that making money cheaper is exactly the wrong step to help keep inflation under control. If foreign investors see that these rate cuts make too much money available to consumers, they will likely have a greater fear of inflation, and thus require a higher yield on long term home loan investments.
While no one can accurately predict long term home loan rates, it is entirely possible that the Fed may find it necessary to take additional steps to prevent a recession. If that happens, home loan rates may very well move higher than they are now.
Q: Isn't it smart to wait and see if home prices continue to drop more than they already have?
A: The most recent information from the government indicates that prices in Georgia have not dropped. In fact, on average, home values in Georgia and the Atlanta area have continued to appreciate, although at a very slow rate. For details, visit ofheo.gov and read about the Home Price Index.
And even if you believe that prices are moving down, how will you know when the bottom of the cycle will arrive? The only way to recognize the bottom is after it has passed, and by then interest rates may be higher.
Q: Is it ever wise to go ahead and purchase a replacement home when you have not yet sold your current residence?
A: Let's say you found the perfect next house. I mean it really was a great fit for you and your family. And let's say you were able to get it at a fabulous price, perhaps as much as thirty or forty thousand dollars below market due to the current market. And let's say you were in a very strong financial position, so that having to carry two monthly payments would not represent a hardship, at least for a while.
Under those circumstances, I would be willing to grant my blessing. But lacking any element of the above scenario makes it too risky to buy before you sell.
No one can say for sure what will happen to our economy in the months ahead, and it's just not a smart move to take on two housing payments if you can avoid it. Remember that there is no such thing as the last house.
Q: If two people apply for a home loan, and one of the applicants has weak credit, can the lender simply choose the better of the two scores?
A: No, if any two people apply for a home loan, the lender will use the lower of the two scores. In many cases, it's better for the lender to consider only the stronger application, and simply allow the weaker applicant to be added to title later.
Q: If we do that, do we have to have a new contract and a new closing?
A: In most cases, the closing attorney will allow the approved applicant to sign the note and security deed in accordance with the lender's instructions. Then after the financial business is finished, the attorney will allow the borrower to sign a warranty deed for a half interest in the property to the weaker applicant.
Q: Since the new Georgia Association of Realtors contract form no longer includes a contingency for financing, what would happen if I were unable to obtain the loan I needed? Would I lose my earnest money?
A: It depends on how the contract is written, but yes, if you signed a standard unaltered GAR contract, you would likely lose your earnest money if you refused to purchased based on a loan problem. This feature of the new contract is designed to prevent buyers from backing out of contracts at the last minute, and is too pro-seller for my taste.
My recommendation is that you specify the time period for inspection of the property be far enough into the future to allow you to obtain final loan approval before you close. I am aware that this would mean that a typical buyer might request a 30 day inspection, but it is the only way I know to make sure the buyer is protected in the event of loan problems.
Alternatively, you could add your own financing contingency provision, but it would only complicate the issue.
Ajc2008-03-30.wpd
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