Buyers and Refinancers Flock to Interest Rate Bargains

by : Jeff Hammerberg

Rather than lowering the numbers cautiously and gradually, which is the Fed's normal policy when tinkering with interest rates, Fed Chairman Ben Bernanke adopted a chainsaw approach during the first month of 2008. Wall Street and other world markets have reacted with mixed emotions so far, but American consumers wanting to buy a home or refinance an existing mortgage are completely ecstatic.

In an ongoing effort to avoid an imminent economic recession the Federal Reserve Bank slashed interest rates in mid-January, during an unscheduled meeting, citing continued concerns about a weakening economy. The Fed lowered its federal funds rate, which influences consumer loans such as retail credit card debt and auto loans. The discount rate - which calculates the interest banks pay to borrow money from the Central Bank - was also cut. Both rates were lowered by three-quarters of a point, the biggest single-day rate cut since October 1984. The historic decision to dramatically drop rates was the first to happen between regularly scheduled meetings since a half-point cut that occurred September 12, 2001, the morning after the terrorist attacks.

Although mortgage interest rates are not directly tied to the fed funds or discount rate, they typically follow the direction of those rates in a rather predictable fashion. Kicking off 2008 with cheap rates naturally gave borrowers plenty of reasons to cheer - and to lock-in the newer rates while there was still time to grab them. But one surprise followed another, and consumers who rushed to confirm their mortgage rates may have experienced some degree of remorse nine days later. When the Fed met then - for its official monthly session - the panel voted to lop off another half of a point. Interest rates for some 30-year fixed mortgages have subsequently slipped under 5 ? percent, while 15-year fixed rate mortgages can be found for less than 5 percent.

To illustrate the quickness and severity of these cuts, consider that the federal funds rate was at 5.25 percent just four months ago. Now it is at three percent, and many economists expect to see it go even lower within the next few months. Not only does this bode well for those who want to buy houses, but it may also save hundreds of thousands of homeowners from imminent foreclosure.

For example, millions of adjustable rate mortgages are scheduled to reset within the next 12-18 months. When those payments go up, so will the corresponding monthly payments - and many will not just rise but will actually double in price overnight. But homeowners who refinance away from ARM loans and into inexpensive and easily manageable fixed rates loans will be spared. For that reason alone the Fed may continue to lower rates, and millions of homeowners across the USA are already flocking to their lenders to convert existing adjustable mortgages to fixed rates.

Congress has asked lenders to aggressively pursue creative strategies for helping homeowners 'rework' subprime loans by showing leniency and flexibility. Some mortgage companies have adopted voluntary measures like rate hike moratoriums to give homeowners time to get back on their feet. Meanwhile, the government's deadline for mortgage lenders to rework adjustable rate loans scheduled to reset is fast approaching. Unless lenders independently come up with plans to resolve the crisis, officials in Washington say they will intervene with mandatory guidelines.

But there are other homeowners - many of whom have excellent credit histories - who are not covered by plans which exclusively target subprime mortgage holders. For example, the market for jumbo loans - those for amounts above $417,000 - is also in turmoil. Many consumers who have adjustable rate jumbos are unable to refinance because the investors who normally fund those high dollar mortgages are afraid to participate in the current volatile jumbo arena. But the new economic stimulus package being crafted by Congress may bring relief to those homeowners. Many in Congress are hopeful that the stimulus package will include a proposal to let Fannie Mae and Freddie Mac temporarily finance jumbo loans, since the two agencies are currently prohibited from dealing in any loans of that magnitude. According the National Association of Realtors, getting Fannie Mae and Freddie Mac into the jumbo lending game will not only provide much-needed loan liquidity but could actually prevent as many as 140,000 foreclosures.

In order to keep the looming recession at bay, the Fed could continue to make cuts, as it did in 2001, when rates were whittled all the way down to one percentage point. Of course if prevailing rates go to one percent, that leaves little wiggle room for the Fed to operate within if the economy continues to sink. But in the meantime those who are interested in more affordable monthly payments have a rare opportunity to buy, refinance, or take out a home equity loan or line of credit at fire sale prices.