I Want My Four Point Five!

...Okay folks, get ready for a long one, but hopefully worth the read! :)

I want my Four Point Five, interest rate that is… That’s right, we’re all sitting around waiting for that 4.5% interest rate that the Feds promised. After all, it’s the only thing that will get our economy turned around right?
Well, that and the new pork belly stimulus package, but that’s a different subject all together.

We’re here today to try and understand why interest rates haven’t dropped to 4.5% like the Fed promised. The answer is in something called the Mortgage Backed Securities (MBS) market and the Treasury Bond (TSY) market.

I wish the explanation of how these markets work was simple but it’s not so I’ll try to summarize using visual analogies.

Imagine a table covered with stacks of little square crackers. All the crackers look the same but their not. Some have a little salt on them, some have no salt on them and some, well, they have a whole lot of salt on them.

Now imagine that you live on a diet of crackers and salt. Sometimes you need more salt and sometimes you need less, BUT! you always need crackers. On days when you need a lot of salt and you have to compete with others that need the salt too, you’ll pay more for the very salty stack of crackers and pay less for the unsalted stack.

Supply and demand comes into affect. There is a limited supply of stacks of very salty crackers and everybody wants them, this drives the price of the very salty cracker stacks way up!

This is what is supposed to happen in the MBS (Mortgage Backed Securities) market. There are pools of securities called Stacks. A share of a stack, one cracker if you will, starts out worth $100.

These stacks come with different layers of salt or interest rates. So you’ve got a stack that pays a 4% rate, 4.25% rate, 4.5% rate, 5% rate and so it goes. Because of the varying returns on each of these stacks, the price of the share (the cracker) in the stack will vary based on the number of buyers for that stack.

So, if nobody wants a 4% return, the $100 share might be sold for $98. If everybody wants a 5% return then a cracker …uhumm, I mean share, in that stack might sell for $102 dollars. Why is this important?

Well, it’s important because these interest rates represent a yield to the owner and that yield affects the interest rates that you and I pay on a long-term mortgage. Get the picture?

The higher the price above $100, the lower the actual yield or return to the owner is. When the price of the shares in the stack increases the yield decreases and the net result is lower interest rates. In simplified terms this is the way the MBS market works and it is how banks determine the interest rates we pay on our loans.

Now, on to the problem at hand! Why aren’t rates going down? Rates are not decreasing because everybody has figured out the game. In order to make rates go down, the Fed has to buy up stacks of Mortgage Backed Securities.

In order to fund these purchase the Fed did two things. They sold Treasury Notes (TSY) and they printed money. When this happened ‘the jig was up’ on many levels.

First, foreign governments saw us diluting our dollar and flooding the bond market so they stopped buying our debt. Big problem! This caused the price of TSY to drop and the yield to increase, it also caused the Fed to have less buying power.

Second, many banks spied an opportunity! If they could get some extra stacks out in the market, maybe the Fed would buy them and pay a premium. Bonus time, right?! Not so much.

What ultimately happened was the ‘Market’ (that’s right, with a big M) figured out what was going on. The MBS market was flooded with stacks. Everybody want a piece of the Feds action. i.e. all the banks wanted some more of our tax dollars, like the bailout funds weren’t enough!

When these stacks flooded the market the Fed could not absorb them all and the price on the stacks dropped sharply. This increased the yield and ultimately increased the interest rates we are offered on mortgages!

Now the markets are starting to settle again and the overload of stacks is being slowly absorbed. Here's the $64,000 question, when will rates dip below 5% again?

I’m not sure, but my guess is as soon as the government stops tinkering with it all. If they would just let the markets work, rates would have come down naturally. Every time the Fed does something like this it seems to put us 30 days farther out.

I want my 4.5 and I know you want yours too. My suggestion is to get out there, choose a lender and get approved and then be patient and wait for the rate that is right for you. When you see it, grab it! Chances are it won’t be there for long….

Michael Gross is the President of Dividend America Mortgage and has been in real estate for over 20 years. He has been a builder, a Realtor, an appraiser, and currently he is a lender and an active real estate investor. He uses all of his experience and knowledge to show individuals how to properly use a mortgage as a tool to help create greater wealth through real estate investing. For more information on residential and small commercial loans please call 770-350-7373 or email mgross@dividendamerica.com

Its the Economy Stupid

After a fairly frustrating week of hyper active rate fluctuations I collapsed on Saturday, tired, worried and spent. Interest rates are at their lowest level in years yet nobody is willing to pull the trigger on a refi to lower their rate.

Housing prices are at their lowest level in years and no one is willing to make an offer to buy. Rents are rising, foreclosures are rising and the only good news is gas prices are falling. So what's the problem. It's this economy!

I remember talking about this day way back in December 2007. Back then I said we were in a recession and back then everyone, including my wife, just about clobbered me saying I didn't know what I was talking about.

But as it turns out, this stupid hick with a high school education from the southside of Atlanta was right! http://www.marketwatch.com/news/story/US-Q3-GDP-down-05/story.aspx?guid=%7B282E197A%2DAE1C%2D47AE%2DB0EB%2D7C9F6C8C951F%7D
As reported on MarketWatch.com, a division of The Wall Street Journal; " Economists now say that a recession began December 2007..." Boo-ya! Sorry for the glee, but I love it when I'm right.

So why my glee? Not just because I'm right, but because business is cyclical. Once business and government realizes and admits that there is a problem, solutions begin to happen. We've been through a tough year and may have a little longer to go, but ultimately our economy will turn around.

Between now and the summer of 2009 we will hit true bottom. After that the economy should begin a slow rise out of the doldrums. We should remember our history. Other than The Great Depressiona, no other ecomomic downturn has lasted more than a couple of years including the huge recession at the end of the Carter administration.

So after some thoughtful introspection I've come to a realization. It's the economy stupid, that's why business is slow and that's why people make some of the poor economic decisions they make. But the smart players, the ones who don't let fear guide their decisions, will be happy that they refinanced their homes and made offers and bought new property for their portfolios during these scary times.

Michael Gross is the President of Dividend America Mortgage and has been in real estate for over 20 years. He has been a builder, a Realtor, an appraiser, and currently he is a lender and an active real estate investor. He uses all of his experience and knowledge to show individuals how to properly use a mortgage as a tool to help create greater wealth through real estate investing. For more information on residential and small commercial loans please call 770-350-7373 or email mgross@dividendamerica.com

Don't Play the Rate Game!

Don't playt he rate game, here's why! The chart to the right shows the 10-Year Treasury Yield for October 8th, 2008. The Yield shot up to 3.72%, up 21 basis point from the previous day!

How could this be possible? Didn't the Fed announce that they were dropping the Fed Funds rate by 0.50% today? Didn't that reporter just say that rates were lower and this was being done to heat up the economy?

Now everyone is demanding a lower rate! After all the Fed just lowered the rates and everyone should expect their rate will be lowered too! Correct?

But hold on just a minute. That's no really how it works. You see the Fed Funds rate controls short-term lending. This would be the rates tied to your car loans, furniture and appliance purchases and credit card rates. If you want a lower rate on something, call that credit card company and demand a lower rate from them.

Mortgage professionals deal in long-term rates. These rates are set in the MBS (Mortgage Backed Securities) market and they closely follow the yield on the 10-Year Treasury Bond. (see the chart above) As you can see the yield on this bond jumped drastically. A 20+ basis point jump is unheard of in a market that thinks a 5 basis point swing is volatile.

In layman's terms, this means that the interest rates on long-term debt is increasing today, not decreasing. Let me try to simplify why this is.....

When people buy bonds they are seeking two things; safety and income. When the Fed lowers the interest rate on short-term debt they are trying to stimulate the economy. Essentially there ain't enough consumin' goin' on and they are trying to get the party started .....to coin a line from an old 90's club tune.... let's get this party start right! let's get this party started quickly! RIGHT!

When the econ heats up you get inflation. Inflation eats away at the value and the income of fixed assets like bonds. So investors sell the bonds rapidly because they are better off putting their money under the mattress than having it in stocks or bonds at the moment.

So as these bonds get sold off rapidly the laws of supply and demand come into play. There is an abundant supply of bonds for sale but a lack of buyers. This causes the price of the bonds to decline rapidly. As the price declines the yield increases. Since long-term interest rates are tied to bond yields, BAM, long-term interest rise.

So for the time being rates on long-term debt will rise or in a best case scenario, the will remain unchanged. If the economy continues to deteriorate we may see interest rates ease. The bottom line is that you should lock in gains now. If you feel that the rate you have chosen on your long-term debt is good then lock it down and close the loan.

In this credit crisis it is to risky to play the 'rate watch' game. Make a solid decision about what is right for you, your family and your business and lock it in. Then spend the next couple of years doing all that you can do to eliminate the debt as quickly as possible.

And then let's pray that whoever is the next President of our great nation understands how to get our economy moving again.

Michael Gross is the President of Dividend America Mortgage and has been in real estate for over 20 years. He has been a builder, a Realtor, an appraiser, and currently he is a lender and an active real estate investor. He uses all of his experience and knowledge to show individuals how to properly use a mortgage as a tool to help create greater wealth through real estate investing. For more information on residential and small commercial loans please call 770-350-7373 or email mgross@dividendamerica.com