The President's 2010 Budget makes a historic commitment to increasing college access and success by expanding financial aid while making it simpler, more reliable, and more efficient. Under the Budget, the Department of Education will administer over $129 billion in new grants, loans, and work-study assistance in 2010—a 32 percent increase over the amount available in 2008—to help more than 14 million students and their families pay for college.
More specifically, the request would establish a Pell Grant maximum of $5,550 for the 2010-11 academic year and then index the maximum grant to grow faster than inflation in future years (at a rate equal to the consumer price index plus 1 percentage point). The Budget would also make Pell Grant funding mandatory, rather than discretionary, to eliminate uncertainty and end the practice of "backfilling" billions of dollars in Pell shortfalls. These changes would result in a 2-year increase in funding for Pell Grants (from the 2008-09 school year to the 2010-11 school year) of $10.4 billion, or 57 percent. The number of recipients would rise by nearly 1.5 million, or 24 percent, over the same period.
The Budget also asks Congress to end entitlements for financial institutions that process Federal postsecondary student loans to students and parents. The Federal Family Education Loan (FFEL) program relies on excessive subsidies and no longer is capable of playing its historical role of raising private capital to help finance Federal student loan programs. As a result, FFEL needlessly costs taxpayers billions of dollars and subjects students to uncertainty because of turmoil in the financial markets. The request would address these problems by making all new loans through the direct lending program. Direct lending takes advantage of low-cost and stable sources of capital so students are ensured access to loans and provided high-quality servicing by using competitive, private-sector providers to process loans and payments. Using direct lending to originate and service all new postsecondary student loans would save an estimated $21 billion over 5 years, savings that would be reinvested in student aid through the expanded Pell Grant program.
In addition, the request proposes to expand and modernize the Perkins Loan program so that it would provide $6 billion a year in new loan volume—six times the current Perkins volume—for up to 2.7 million students at roughly 2,700 additional postsecondary education institutions. The loans would have the same low 5 percent interest rate and allowed loan amounts (both undergraduate and graduate) as in the current Perkins program. Institutional loan forgiveness costs on existing loans, currently supported by discretionary appropriations, would be fully funded from the Federal share of Perkins Loan collections. To make loans more broadly available and help finance the expanded Pell Grant, interest on the loans would accrue while students are in school. The Department would service Perkins Loans along with other Federal loans, with estimated overall savings totaling $3.2 billion over 5 years.
Finally, the proposed College Access and Completion Fund would invest $2.5 billion in mandatory funding over 5 years to build a Federal-State-local partnership to improve college success and completion, particularly for students from disadvantaged backgrounds. This initiative would provide flexible funding to States and national entities to help expand the knowledge base about what works in increasing college enrollment and graduation and disseminate these best practices.
Monday, August 16, 2010
Affect on credit by foreclosure
Foreclosed on? Just because you may have lost one home doesn’t mean you’ll never be able to buy another. But first, you need to engage in some credit score Rx.
“A foreclosure will cause a credit score to drop sharply, typically by 200 to 300 points,” says Andrew Housser, co-CEO of Bills.com, a free consumer portal of personal finance information. “That would drop a score of 700 – considered a ‘good’ score – to as low as 400 – considered pretty terrible.” The minimum FICO score is 340. This drop can affect your ability to not only purchase a home, but also to secure a car loan and even gain employment. “Lower credit scores can result in being denied credit, such as credit cards and car loans, and facing much higher rates for loans and even other items, such as insurance, that rely on credit scores,” notes Housser.
Don’t lose hope, though. While a foreclosure can remain on your credit report for seven years, it won’t ruin your credit score for life, adds Housser. “If you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years. The important thing to keep in mind is that a foreclosure is a single negative item. If you keep it isolated, it will be much less damaging to your FICO score than if you had a foreclosure in addition to defaulting on other credit obligations.”
In fact, The Federal Housing Administration will allow a new mortgage to be approved if a past foreclosure was more than five years old,” explains Alan M. White, assistant professor at Valparaiso University School of Law in Indiana. “The impact of foreclosure on your score diminishes over time, depending on whether you have other active, on-time accounts,” he explains.
Of course, it’s preferable to avoid foreclosure altogether. Here are some ways to accomplish that goal. (Keep in mind, however, that many of these options require you to resume normal mortgage payments at some point. If you can’t afford to resume payments, it may not be worth the effort required to stop or reverse the foreclosure process.)
• Lender negotiation: If there is a reasonable expectation that you will be able to resume making regular mortgage payments within a relatively short time frame, the lender may be willing to work with you to establish a payment plan to bring the loan current. “Especially in today’s market, this is a greater possibility,” says Housser. “Many individuals are having trouble due to an unexpected job loss, medical expenses, divorce or other personal trauma. If the situation has some resolution so that the regular payments may be able to be met again, it is worth it to call the lender.”
• Forbearance agreement: For a temporary hardship, the lender might grant you a forbearance agreement to lower – or eliminate – payments for a limited time.
• Loan modification: This entails a permanent change to the loan, such as lowering the payment and extending the loan’s term or incorporating any delinquencies into future payments. “Lenders are more willing to discuss this now than they were before,” adds Housser.
• Deed-in-lieu of foreclosure: In this case, the lender takes ownership of the home, but that will not eliminate the negative impact of a payment delinquency or foreclosure that has already begun. “Bankruptcy remains on a credit report for 10 years, but it can offer a way to become current in payments, which will improve the credit score,” White notes.
• Refinancing: It may be possible to refinance a mortgage for a lower interest rate and/or lower monthly payment. But if you have already had late payments on a mortgage, the interest rate offered may be too high to lower your monthly payment. Housser recommends using online rate comparison sites and calculators to determine the “real costs of refinancing.”
• Short sale: In a short sale, the lender accepts less than the mortgage debt when the property value has declined. “A short sale will prevent foreclosure,” says White. “However, if it takes place after foreclosure was initiated, the foreclosure and the related delinquency in payments will be reflected on the credit report.” The only way to protect the credit score fully is to maintain monthly payments until the house is sold.
• Chapter 13 bankruptcy: If the loan default is past the point of being resolved with the lender, you may file for chapter 13 bankruptcy protection. This protection requires you to resume making regular mortgage payments but allows the arrearage (being overdue in payment) to be repaid over the course of the chapter 13 plan.
All things considered, a foreclosure won’t ruin your credit rating forever. It will lower your credit score and remain on your credit report until you’re able to re-establish good credit — which takes time and careful planning. Consider your home purchase wisely.
“A foreclosure will cause a credit score to drop sharply, typically by 200 to 300 points,” says Andrew Housser, co-CEO of Bills.com, a free consumer portal of personal finance information. “That would drop a score of 700 – considered a ‘good’ score – to as low as 400 – considered pretty terrible.” The minimum FICO score is 340. This drop can affect your ability to not only purchase a home, but also to secure a car loan and even gain employment. “Lower credit scores can result in being denied credit, such as credit cards and car loans, and facing much higher rates for loans and even other items, such as insurance, that rely on credit scores,” notes Housser.
Don’t lose hope, though. While a foreclosure can remain on your credit report for seven years, it won’t ruin your credit score for life, adds Housser. “If you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years. The important thing to keep in mind is that a foreclosure is a single negative item. If you keep it isolated, it will be much less damaging to your FICO score than if you had a foreclosure in addition to defaulting on other credit obligations.”
In fact, The Federal Housing Administration will allow a new mortgage to be approved if a past foreclosure was more than five years old,” explains Alan M. White, assistant professor at Valparaiso University School of Law in Indiana. “The impact of foreclosure on your score diminishes over time, depending on whether you have other active, on-time accounts,” he explains.
Of course, it’s preferable to avoid foreclosure altogether. Here are some ways to accomplish that goal. (Keep in mind, however, that many of these options require you to resume normal mortgage payments at some point. If you can’t afford to resume payments, it may not be worth the effort required to stop or reverse the foreclosure process.)
• Lender negotiation: If there is a reasonable expectation that you will be able to resume making regular mortgage payments within a relatively short time frame, the lender may be willing to work with you to establish a payment plan to bring the loan current. “Especially in today’s market, this is a greater possibility,” says Housser. “Many individuals are having trouble due to an unexpected job loss, medical expenses, divorce or other personal trauma. If the situation has some resolution so that the regular payments may be able to be met again, it is worth it to call the lender.”
• Forbearance agreement: For a temporary hardship, the lender might grant you a forbearance agreement to lower – or eliminate – payments for a limited time.
• Loan modification: This entails a permanent change to the loan, such as lowering the payment and extending the loan’s term or incorporating any delinquencies into future payments. “Lenders are more willing to discuss this now than they were before,” adds Housser.
• Deed-in-lieu of foreclosure: In this case, the lender takes ownership of the home, but that will not eliminate the negative impact of a payment delinquency or foreclosure that has already begun. “Bankruptcy remains on a credit report for 10 years, but it can offer a way to become current in payments, which will improve the credit score,” White notes.
• Refinancing: It may be possible to refinance a mortgage for a lower interest rate and/or lower monthly payment. But if you have already had late payments on a mortgage, the interest rate offered may be too high to lower your monthly payment. Housser recommends using online rate comparison sites and calculators to determine the “real costs of refinancing.”
• Short sale: In a short sale, the lender accepts less than the mortgage debt when the property value has declined. “A short sale will prevent foreclosure,” says White. “However, if it takes place after foreclosure was initiated, the foreclosure and the related delinquency in payments will be reflected on the credit report.” The only way to protect the credit score fully is to maintain monthly payments until the house is sold.
• Chapter 13 bankruptcy: If the loan default is past the point of being resolved with the lender, you may file for chapter 13 bankruptcy protection. This protection requires you to resume making regular mortgage payments but allows the arrearage (being overdue in payment) to be repaid over the course of the chapter 13 plan.
All things considered, a foreclosure won’t ruin your credit rating forever. It will lower your credit score and remain on your credit report until you’re able to re-establish good credit — which takes time and careful planning. Consider your home purchase wisely.
Mortgage rate changes
The questions are simple enough: What's going on with mortgage rates?
What makes them rise, or fall? Is it the Fed? The economy? Inflation? The banks? The President? Fannie Mae or Freddie Mac? Is it a secret conspiracy?
The answer is that rates are moved by a number of related factors, and believe it or not, you -- Joe or Jane Consumer -- are one of those factors.
Mortgage money can come from many sources, including deposits at banks and brokerages, but most comes from investors through what is collectively known as the "capital markets." This is where investors interested in purchasing certain kinds of debt instruments -- bonds, in this case -- come to buy these items.
In order to attract investors, sellers of bonds must compete with one another to get their money. They do this by offering a variety of " instruments" (also called "product") with differing structures of risk and return over given periods of time. These offerings compete with other investments which are reasonably similar in performance, such as US Treasuries, corporate bonds, foreign bonds, and others.
Who are these investors, and why are they so fickle? Mostly, they're people like you, and you want two opposing things: low payments on your debt, especially your mortgage, and high returns on your investments. You (or your investment advisors or fund managers) will only buy so many low- yielding bonds (mortgage or otherwise), because you'll take your money elsewhere if your returns are too low.
Investor demand for a given kind of investment plays a considerable role in moving market yields, because investors have literally hundreds of places to put their money. It's a crowded marketplace, with many sellers of various product competing for those investor dollars. Investor demand for specific product rises and falls with changes in investment strategies; if demand falls enough, a change needs to be made to attract investors again. How to attract them again? Usually, by raising interest rates.
Of course, it's not as easy or simple as that. Mortgage market makers serve not one client, but two: investors, who want the highest possible return on their investments, and the homeowner or homebuyer, who wants the lowest possible interest rate. Simultaneously, rates need to be high enough to attract investors but low enough to attract borrowers. It's quite a complex dance; investors, though, make the music.
As interest rates (yields) decline, investment customers can become more or less interested, depending upon the direction of economic growth, inflation, appetite for the given product, and several other factors. Typically, though, the lower those rates get, the fewer investors are interested in putting them on their books.
In the case of financial instruments like bonds, things get a little more complicated. Bonds have an interest rate (yield), a dollar amount (face) and a current price (price).
A very simple explanation -- which leaves out a number of very important factors -- would be as follows:
Let's say, for example, that you want to sell a $1,000 (face) bond with a yield of 6%. And let's say that it's a good deal, so ten investors start offering you more than the $1,000 you want. They bid the price up to $1,010 -- $1,020 -- $1,030. In effect, that increase in price is actually borrowing from the interest which the bond will return. Because some of the interest is gone, the actual return to the investor is no longer 6%, but something less than that. When demand for a given bond is strong, prices rise to the seller, and the return to the investor (yield) declines.
Conversely, when demand for a given bond is weak, the price falls. For example, you might have to sell that $1,000 for only $980; and the return to the investor (yield) rises, since the buyer not only gets all the interest on $1,000, but also got a discount on his purchase price.
The principle to remember is this: as a bond price rises, its yield falls, and vice-versa.
Relationships to Other Investments
Mortgages are priced for sale to attract investors who seek fixed income investments. There are many kinds of bonds available, and mortgage rates (yields) rise and fall with those competing investments to a greater or lesser degree.
But how to price them? Fixed mortgage rates, like other bonds, track US Treasury bonds quite well. Since Treasury obligations are backed by the "full faith and credit" of the United States, they are the benchmark for many other bonds.
There is no specific "lockstep" relationship between Treasuries of any term and fixed mortgage rates. Given enough data points, a relationship could be established against many different financial instruments. However, as a 30-year fixed rate mortgage rarely lasts longer than about 10 years before being paid off or refinanced, the closest instrument which has similar (though lesser) risks is the ten-year Treasury Constant Maturity. Because of this, the ten-year year Treasury makes an excellent tool to track mortgage rates.
Here's an oversimplification of the relationships of mortgages to Treasuries:
As we mentioned, intermediate term bonds and long-term mortgages (more properly, Mortgage-Backed Securities, or MBS) compete for the same fixed-income investor dollar. Treasury issues are 100% guaranteed to be repaid, but mortgages are not; therefore mortgages carry more risk of default or early repayment, which could potentially disturb the return on the investment. Therefore, mortgage rates must be priced higher to compensate for that risk.
But how much higher are mortgages priced? In a normal market, the average "spread" or markup above the 100% secured Treasury is about 170 basis points, or 1.7%. That markup -- the spread relationship -- widens and contracts with a range of market conditions, investor appetites and supply of available product -- as well as the presence of competing investment opportunities, like corporate bonds or domestic (or foreign) equity markets. Professional money managers, and investment and retirement funds constantly strive to obtain high-yielding instruments at a given level of risk. Money shuffles from place to place in search of this -- from bond to bond, and market to market.
As we mentioned, the relationship isn't a fixed one, but one that changes with market conditions. Recently, for example, ten-year Treasuries rose from of 3.30% to 3.94% over a period of a few months -- about 64 basis points, altogether. At the same time, the the average overall 30-year fixed mortgage rate rose from about 5.29% to 5.41%, a rise of only 12 basis points. Over time, there are any number of examples where Treasury yields have risen faster than mortgage rates, as well as times when mortgage rates rose faster than Treasury yields. Consequently, the spread between the two expands and narrows appreciably, which is why you can't simply take the ten-year yield, add 1.7% to it and know exactly what today's rate is. It goes without saying that these 'spread' relationships vary by mortgage product and also by whether a loan will be held in a lender's portfolio or sold to other entities.
An update, in light of more recent market events
All of the above text assumes for the most part that we are in a fairly normal marketplace. It goes without saying that mortgage and bond markets have been far from normal in recent years.
It may be some time until we return to normal mortgage markets, fully free of extraordinary efforts by government, and where private-market investor needs shape the marketplace. That said, we are starting to move in that direction again.
A large influencing force in the mortgage market came to an end in April 2010, as the Federal Reserve finished its program of purchasing $1.25 Trillion in Mortgage-Backed Securities. Since the Fed not only bought new production from Fannie Mae, Freddie Mac and Ginnie Mae (FHA-backed loans) but also certain existing "agency" stock from investors, there remains in the market some momentum from the program, as investors look to re-fill holes in their portfolios with newly-issues, often better-quality mortgage investments.
At the same time, some additional holes in investor portfolios were created when Fannie Mae and Freddie Mac decided to re-acquire up to $200 Billion of previously-securitized-but-now-failing loans from investors, an occurrence allowed under the terms of the guarantees which accompany the MBS issued by these entities. Like a portion of the Fed program above, retiring these holdings means that at least some new private-market demand for newly-issues MBS should occur.
This increase in demand by investors for new MBS means that prices for those MBS should remain fairly firm for a while, which in turn means that low yields -- low mortgage rates -- should be with us for at least a little while, too.
So there should be at least some demand for new securities. What about supply... will new supply overwhelm the demand in the market? Probably not, at least for a while. With home sales well below peak levels, and even small flares in interest rates making sizable dents in the refinance market, the number of new loans coming into these security machines isn't all that strong, so there shouldn't need to be a cascade of supply into the market. Better still, even if demand for MBS doesn't remain constant, Fannie and Freddie have considerable space to balloon their portfolios of loans (upstream of turning them into securities) and so can release new MBS supply into the market at a measured pace, which should also serve to stabilize prices, keeping rates level.
In a nutshell, the Fed may have stepped away from the mortgage market, but there are now different mechanisms in place which should have much of the same effect of keeping rates fairly low and steady, at least for a time.
Other Factors
Then, there's the "unknown supply stream", aka "volume". Unlike many other investment opportunities, no one really knows how many mortgages will be originated, then made available for sale (as bonds) in a given period of time. Recently, a quick drop in interest rates produced a large buildup of loans to be sold to investors as homeowners rushed to refinance. This made way too much bond supply available in too short a time, and investors simply couldn't absorb it all at once. Too much supply, not enough demand; prices had to go down, and yields had to go up to attract investors.
Delays, Delays
There's also a time-lag for mortgage pricing. Though shorter than in years past, it takes anywhere from several hours to several days for increase or decreases to get from capital markets to wholesalers to retailers to "the street" where loan originators are working with you.
Not all increases or decreases are passed along, either. Depending upon the size of the change, rates may stay the same (but fees, such as points, may change). Sometimes, a minor increase in bond yields in the morning is followed by a minor decrease in the afternoon, while mortgage rates remain the same all day.
Other Risks
There's also the impact of inflation, which affects both Treasury, mortgage and other fixed-income investments. Rising inflation reduces the actual return on a fixed interest rate investment, so with 2% inflation, that 6% mortgage note returns only 4% "real" interest.
If inflation is expected to decline for the foreseeable future, you can bet that mortgage rates have some room to fall. Conversely, an outlook which suggests higher inflation ahead will see mortgage rates rise, sometimes very quickly.
Also, a poor economic climate affects mortgages much more profoundly than Treasuries. After all, the US government isn't likely to lose its job and suddenly stop making payments, but it's a safe bet that a percentage of homeowners will, even in good economic times.
There's much more to the structure or bond, mortgage and capital markets, including government influences and overseas relationships to our capital markets which can also have an effect, but the above should be enough to give you a modest working knowledge of the market. You'll notice that so far, we didn't mention the Fed at all. Fed moves have no direct effect on fixed rate mortgage pricing, but their action or inaction (and expectations thereof) can indeed have indirect effects.
The Fed's Role
Contrary to popular myth, the Fed (more properly, the Federal Reserve) doesn't control mortgage rates. (For more on this, click here.) In fact, their most well-known policy tool -- the Federal Funds rate -- is the overnight interest rate which banks charge each other when a bank needs to borrow money to meet end- of-day reserve requirements. Simply, those rules say that a bank must have so much cash on hand when the books close at the end of the day, and those funds can be borrowed from another bank at this interest rate. You should know that the Fed merely "suggests" what that rate should be, which is why it's called a "target" rate; the actual rate is negotiated between the borrower bank and the lender bank.
A good way to keep a handle on the Fed is to remember that the Fed Funds rate is the shortest of short-term rates -- literally, an overnight loan -- and a fixed-rate mortgage is all the way at the other end of the scale, a loan that lasts as long as 30 years.
From Fed Funds moves, there's a complicated discussion of monetary policy about how Fed moves affect certain deposit and loan markets and inflationary expectations. We'll leave that for another article.
The end result is that the Fed raises or lowers interest rates to help address increases or decreases in economic activity. Lower rates can help banks to make certain kinds of loans more cheaply, especially for business and certain kinds of consumer lending, and that can help to generate greater economic growth. Higher rates can cool demand, helping to keep inflationary pressures from forming.
In some ways, expectations of what the Fed might do can be more important than what the Fed actually does, as their actions or inactions can help to confirm or deny what investors believe.
You may also have noticed that sometimes the Fed cuts interest rates -- and fixed mortgage rates actually rise as a result. Why? If the Fed is taking steps to address economic weakness by lowering rates, that likely means that a return to faster growth -- and possible higher inflation, as well -- is coming sooner, rather than later.
So what moves mortgage rates? Supply. Demand. Competition for money. Inflation. The Economy. Expectations. And you, of course.
We hope that this helps you understand a little better how the whole thing works.
What makes them rise, or fall? Is it the Fed? The economy? Inflation? The banks? The President? Fannie Mae or Freddie Mac? Is it a secret conspiracy?
The answer is that rates are moved by a number of related factors, and believe it or not, you -- Joe or Jane Consumer -- are one of those factors.
Mortgage money can come from many sources, including deposits at banks and brokerages, but most comes from investors through what is collectively known as the "capital markets." This is where investors interested in purchasing certain kinds of debt instruments -- bonds, in this case -- come to buy these items.
In order to attract investors, sellers of bonds must compete with one another to get their money. They do this by offering a variety of " instruments" (also called "product") with differing structures of risk and return over given periods of time. These offerings compete with other investments which are reasonably similar in performance, such as US Treasuries, corporate bonds, foreign bonds, and others.
Who are these investors, and why are they so fickle? Mostly, they're people like you, and you want two opposing things: low payments on your debt, especially your mortgage, and high returns on your investments. You (or your investment advisors or fund managers) will only buy so many low- yielding bonds (mortgage or otherwise), because you'll take your money elsewhere if your returns are too low.
Investor demand for a given kind of investment plays a considerable role in moving market yields, because investors have literally hundreds of places to put their money. It's a crowded marketplace, with many sellers of various product competing for those investor dollars. Investor demand for specific product rises and falls with changes in investment strategies; if demand falls enough, a change needs to be made to attract investors again. How to attract them again? Usually, by raising interest rates.
Of course, it's not as easy or simple as that. Mortgage market makers serve not one client, but two: investors, who want the highest possible return on their investments, and the homeowner or homebuyer, who wants the lowest possible interest rate. Simultaneously, rates need to be high enough to attract investors but low enough to attract borrowers. It's quite a complex dance; investors, though, make the music.
As interest rates (yields) decline, investment customers can become more or less interested, depending upon the direction of economic growth, inflation, appetite for the given product, and several other factors. Typically, though, the lower those rates get, the fewer investors are interested in putting them on their books.
In the case of financial instruments like bonds, things get a little more complicated. Bonds have an interest rate (yield), a dollar amount (face) and a current price (price).
A very simple explanation -- which leaves out a number of very important factors -- would be as follows:
Let's say, for example, that you want to sell a $1,000 (face) bond with a yield of 6%. And let's say that it's a good deal, so ten investors start offering you more than the $1,000 you want. They bid the price up to $1,010 -- $1,020 -- $1,030. In effect, that increase in price is actually borrowing from the interest which the bond will return. Because some of the interest is gone, the actual return to the investor is no longer 6%, but something less than that. When demand for a given bond is strong, prices rise to the seller, and the return to the investor (yield) declines.
Conversely, when demand for a given bond is weak, the price falls. For example, you might have to sell that $1,000 for only $980; and the return to the investor (yield) rises, since the buyer not only gets all the interest on $1,000, but also got a discount on his purchase price.
The principle to remember is this: as a bond price rises, its yield falls, and vice-versa.
Relationships to Other Investments
Mortgages are priced for sale to attract investors who seek fixed income investments. There are many kinds of bonds available, and mortgage rates (yields) rise and fall with those competing investments to a greater or lesser degree.
But how to price them? Fixed mortgage rates, like other bonds, track US Treasury bonds quite well. Since Treasury obligations are backed by the "full faith and credit" of the United States, they are the benchmark for many other bonds.
There is no specific "lockstep" relationship between Treasuries of any term and fixed mortgage rates. Given enough data points, a relationship could be established against many different financial instruments. However, as a 30-year fixed rate mortgage rarely lasts longer than about 10 years before being paid off or refinanced, the closest instrument which has similar (though lesser) risks is the ten-year Treasury Constant Maturity. Because of this, the ten-year year Treasury makes an excellent tool to track mortgage rates.
Here's an oversimplification of the relationships of mortgages to Treasuries:
As we mentioned, intermediate term bonds and long-term mortgages (more properly, Mortgage-Backed Securities, or MBS) compete for the same fixed-income investor dollar. Treasury issues are 100% guaranteed to be repaid, but mortgages are not; therefore mortgages carry more risk of default or early repayment, which could potentially disturb the return on the investment. Therefore, mortgage rates must be priced higher to compensate for that risk.
But how much higher are mortgages priced? In a normal market, the average "spread" or markup above the 100% secured Treasury is about 170 basis points, or 1.7%. That markup -- the spread relationship -- widens and contracts with a range of market conditions, investor appetites and supply of available product -- as well as the presence of competing investment opportunities, like corporate bonds or domestic (or foreign) equity markets. Professional money managers, and investment and retirement funds constantly strive to obtain high-yielding instruments at a given level of risk. Money shuffles from place to place in search of this -- from bond to bond, and market to market.
As we mentioned, the relationship isn't a fixed one, but one that changes with market conditions. Recently, for example, ten-year Treasuries rose from of 3.30% to 3.94% over a period of a few months -- about 64 basis points, altogether. At the same time, the the average overall 30-year fixed mortgage rate rose from about 5.29% to 5.41%, a rise of only 12 basis points. Over time, there are any number of examples where Treasury yields have risen faster than mortgage rates, as well as times when mortgage rates rose faster than Treasury yields. Consequently, the spread between the two expands and narrows appreciably, which is why you can't simply take the ten-year yield, add 1.7% to it and know exactly what today's rate is. It goes without saying that these 'spread' relationships vary by mortgage product and also by whether a loan will be held in a lender's portfolio or sold to other entities.
An update, in light of more recent market events
All of the above text assumes for the most part that we are in a fairly normal marketplace. It goes without saying that mortgage and bond markets have been far from normal in recent years.
It may be some time until we return to normal mortgage markets, fully free of extraordinary efforts by government, and where private-market investor needs shape the marketplace. That said, we are starting to move in that direction again.
A large influencing force in the mortgage market came to an end in April 2010, as the Federal Reserve finished its program of purchasing $1.25 Trillion in Mortgage-Backed Securities. Since the Fed not only bought new production from Fannie Mae, Freddie Mac and Ginnie Mae (FHA-backed loans) but also certain existing "agency" stock from investors, there remains in the market some momentum from the program, as investors look to re-fill holes in their portfolios with newly-issues, often better-quality mortgage investments.
At the same time, some additional holes in investor portfolios were created when Fannie Mae and Freddie Mac decided to re-acquire up to $200 Billion of previously-securitized-but-now-failing loans from investors, an occurrence allowed under the terms of the guarantees which accompany the MBS issued by these entities. Like a portion of the Fed program above, retiring these holdings means that at least some new private-market demand for newly-issues MBS should occur.
This increase in demand by investors for new MBS means that prices for those MBS should remain fairly firm for a while, which in turn means that low yields -- low mortgage rates -- should be with us for at least a little while, too.
So there should be at least some demand for new securities. What about supply... will new supply overwhelm the demand in the market? Probably not, at least for a while. With home sales well below peak levels, and even small flares in interest rates making sizable dents in the refinance market, the number of new loans coming into these security machines isn't all that strong, so there shouldn't need to be a cascade of supply into the market. Better still, even if demand for MBS doesn't remain constant, Fannie and Freddie have considerable space to balloon their portfolios of loans (upstream of turning them into securities) and so can release new MBS supply into the market at a measured pace, which should also serve to stabilize prices, keeping rates level.
In a nutshell, the Fed may have stepped away from the mortgage market, but there are now different mechanisms in place which should have much of the same effect of keeping rates fairly low and steady, at least for a time.
Other Factors
Then, there's the "unknown supply stream", aka "volume". Unlike many other investment opportunities, no one really knows how many mortgages will be originated, then made available for sale (as bonds) in a given period of time. Recently, a quick drop in interest rates produced a large buildup of loans to be sold to investors as homeowners rushed to refinance. This made way too much bond supply available in too short a time, and investors simply couldn't absorb it all at once. Too much supply, not enough demand; prices had to go down, and yields had to go up to attract investors.
Delays, Delays
There's also a time-lag for mortgage pricing. Though shorter than in years past, it takes anywhere from several hours to several days for increase or decreases to get from capital markets to wholesalers to retailers to "the street" where loan originators are working with you.
Not all increases or decreases are passed along, either. Depending upon the size of the change, rates may stay the same (but fees, such as points, may change). Sometimes, a minor increase in bond yields in the morning is followed by a minor decrease in the afternoon, while mortgage rates remain the same all day.
Other Risks
There's also the impact of inflation, which affects both Treasury, mortgage and other fixed-income investments. Rising inflation reduces the actual return on a fixed interest rate investment, so with 2% inflation, that 6% mortgage note returns only 4% "real" interest.
If inflation is expected to decline for the foreseeable future, you can bet that mortgage rates have some room to fall. Conversely, an outlook which suggests higher inflation ahead will see mortgage rates rise, sometimes very quickly.
Also, a poor economic climate affects mortgages much more profoundly than Treasuries. After all, the US government isn't likely to lose its job and suddenly stop making payments, but it's a safe bet that a percentage of homeowners will, even in good economic times.
There's much more to the structure or bond, mortgage and capital markets, including government influences and overseas relationships to our capital markets which can also have an effect, but the above should be enough to give you a modest working knowledge of the market. You'll notice that so far, we didn't mention the Fed at all. Fed moves have no direct effect on fixed rate mortgage pricing, but their action or inaction (and expectations thereof) can indeed have indirect effects.
The Fed's Role
Contrary to popular myth, the Fed (more properly, the Federal Reserve) doesn't control mortgage rates. (For more on this, click here.) In fact, their most well-known policy tool -- the Federal Funds rate -- is the overnight interest rate which banks charge each other when a bank needs to borrow money to meet end- of-day reserve requirements. Simply, those rules say that a bank must have so much cash on hand when the books close at the end of the day, and those funds can be borrowed from another bank at this interest rate. You should know that the Fed merely "suggests" what that rate should be, which is why it's called a "target" rate; the actual rate is negotiated between the borrower bank and the lender bank.
A good way to keep a handle on the Fed is to remember that the Fed Funds rate is the shortest of short-term rates -- literally, an overnight loan -- and a fixed-rate mortgage is all the way at the other end of the scale, a loan that lasts as long as 30 years.
From Fed Funds moves, there's a complicated discussion of monetary policy about how Fed moves affect certain deposit and loan markets and inflationary expectations. We'll leave that for another article.
The end result is that the Fed raises or lowers interest rates to help address increases or decreases in economic activity. Lower rates can help banks to make certain kinds of loans more cheaply, especially for business and certain kinds of consumer lending, and that can help to generate greater economic growth. Higher rates can cool demand, helping to keep inflationary pressures from forming.
In some ways, expectations of what the Fed might do can be more important than what the Fed actually does, as their actions or inactions can help to confirm or deny what investors believe.
You may also have noticed that sometimes the Fed cuts interest rates -- and fixed mortgage rates actually rise as a result. Why? If the Fed is taking steps to address economic weakness by lowering rates, that likely means that a return to faster growth -- and possible higher inflation, as well -- is coming sooner, rather than later.
So what moves mortgage rates? Supply. Demand. Competition for money. Inflation. The Economy. Expectations. And you, of course.
We hope that this helps you understand a little better how the whole thing works.
Rising economic powerhouse
India, China and other emerging markets will reap the rewards of a historic shift in global economic power if they “do everything right,” said Nouriel Roubini, the New York University economist who predicted the financial crisis.
While the economies of India and China are still not large enough to lead global growth, they and other emerging markets remain “bright spots” compared with the U.S., Europe and Japan, which all face deflationary pressures, Roubini said at a conference organized by Edelweiss Capital Ltd. in Mumbai today.
“The size of the emerging markets is going to become larger and larger, and it’s going to become greater than the GDP of the United States,” Roubini said. “It may take 20 to 30 years, depending on relative economic growth, but the process will occur” and “we should get used to it.”
As the U.S., Europe and Japan struggle to recover from the worst recession since World War II, India’s main stock-market index has soared over the last 12 months and its economy may grow 8.2 percent in the year starting April 1, the fastest in two years, the Finance Ministry said in February. Chinese gross domestic product grew 10.7 percent in the three months through December, the quickest pace since the fourth quarter of 2007.
“China has been a hare and India a tortoise but growth is accelerating in India,” Roubini said. Emerging markets are set for a V-shaped recovery, even as India still has a “massive” need for human and financial capital as well as economic-policy changes to achieve double-digit growth like China, he said.
‘Still Damaged’
Financial markets in the U.S. and Europe, meanwhile, are “still damaged” from the crisis and U.S. economic growth may slow in the second half as stimulus measures are phased out and the job market remains “weak,” Roubini said. The U.S. recovery may be U-shaped, he said.
Asian nations from China to India have begun withdrawing monetary stimulus to avert asset bubbles and curb inflation as their economies rebound. Any declines in Indian stocks are an opportunity to add to holdings, Zurich-based Bank Julius Baer & Co. said this week. Investor Mark Mobius this month predicted the nation’s stocks will outperform other emerging markets.
India’s Sensex index has surged 84 percent in the past year. On March 19, the central bank raised the benchmark reverse repurchase rate by a quarter of a percentage point to 3.5 percent and the repurchase rate by the same amount to 5 percent.
India’s stocks will withstand the stimulus withdrawal and extend last year’s rally, the biggest in 18 years, as domestic spending strengthens, John Praveen, the Newark, New Jersey-based chief investment strategist at Prudential International, a unit of Prudential Financial, which oversees $667 billion, said in a March 26 interview.
Ahead of Indo-US Strategic Dialogue, an Obama Administration official termed India as a "great and emerging global power" and said the talks, next week, will take the relationship between the two nations to a new level.
"I think the strategic dialogue speaks for itself. India is a great and emerging global power. Our range of interests are significant in terms of the environment, in terms of regional security, in terms of counterterrorism, economic issues," State Department spokesman P J Crowley told reporters here.
Leading a high-power delegation of several Cabinet Ministers, External Affairs Minister S M Krishna is scheduled to arrive in Washington in the next couple of days for the first Indo-US Strategic Dialogue from June 1 to June 4.
While the names of the Indian delegation has not been announced yet, it is expected that it would include Human Resources Development Minister Kapil Sibal; Deputy Chairman of Planning Commission Montek Singh Ahluwalia; Minister for Science and Technology Prithvitaj Chauhan; and Foreign Secretary, Nirupama Rao.
Secretary of State Hillary Clinton - who returned from her week-long three-nation Asia trip from Japan, China and Seoul -- would lead the American delegation.
During Clinton's visit to India, last year, it was decided that the strategic dialogue should be launched between the two countries.
"We have very strong cultural ties to India, so we look forward to the strategic dialogue. It's something that the Secretary and the President (of the US) felt important to elevate the level of our coordination and cooperation. So we look forward to the dialogue," Crowley said in response to a question.
"I think our relations with India have never been stronger. We are talking about the relations between the largest and oldest democracies in the world. We have a great deal in common and we look forward to the meetings next week," Crowley said.
While the economies of India and China are still not large enough to lead global growth, they and other emerging markets remain “bright spots” compared with the U.S., Europe and Japan, which all face deflationary pressures, Roubini said at a conference organized by Edelweiss Capital Ltd. in Mumbai today.
“The size of the emerging markets is going to become larger and larger, and it’s going to become greater than the GDP of the United States,” Roubini said. “It may take 20 to 30 years, depending on relative economic growth, but the process will occur” and “we should get used to it.”
As the U.S., Europe and Japan struggle to recover from the worst recession since World War II, India’s main stock-market index has soared over the last 12 months and its economy may grow 8.2 percent in the year starting April 1, the fastest in two years, the Finance Ministry said in February. Chinese gross domestic product grew 10.7 percent in the three months through December, the quickest pace since the fourth quarter of 2007.
“China has been a hare and India a tortoise but growth is accelerating in India,” Roubini said. Emerging markets are set for a V-shaped recovery, even as India still has a “massive” need for human and financial capital as well as economic-policy changes to achieve double-digit growth like China, he said.
‘Still Damaged’
Financial markets in the U.S. and Europe, meanwhile, are “still damaged” from the crisis and U.S. economic growth may slow in the second half as stimulus measures are phased out and the job market remains “weak,” Roubini said. The U.S. recovery may be U-shaped, he said.
Asian nations from China to India have begun withdrawing monetary stimulus to avert asset bubbles and curb inflation as their economies rebound. Any declines in Indian stocks are an opportunity to add to holdings, Zurich-based Bank Julius Baer & Co. said this week. Investor Mark Mobius this month predicted the nation’s stocks will outperform other emerging markets.
India’s Sensex index has surged 84 percent in the past year. On March 19, the central bank raised the benchmark reverse repurchase rate by a quarter of a percentage point to 3.5 percent and the repurchase rate by the same amount to 5 percent.
India’s stocks will withstand the stimulus withdrawal and extend last year’s rally, the biggest in 18 years, as domestic spending strengthens, John Praveen, the Newark, New Jersey-based chief investment strategist at Prudential International, a unit of Prudential Financial, which oversees $667 billion, said in a March 26 interview.
Ahead of Indo-US Strategic Dialogue, an Obama Administration official termed India as a "great and emerging global power" and said the talks, next week, will take the relationship between the two nations to a new level.
"I think the strategic dialogue speaks for itself. India is a great and emerging global power. Our range of interests are significant in terms of the environment, in terms of regional security, in terms of counterterrorism, economic issues," State Department spokesman P J Crowley told reporters here.
Leading a high-power delegation of several Cabinet Ministers, External Affairs Minister S M Krishna is scheduled to arrive in Washington in the next couple of days for the first Indo-US Strategic Dialogue from June 1 to June 4.
While the names of the Indian delegation has not been announced yet, it is expected that it would include Human Resources Development Minister Kapil Sibal; Deputy Chairman of Planning Commission Montek Singh Ahluwalia; Minister for Science and Technology Prithvitaj Chauhan; and Foreign Secretary, Nirupama Rao.
Secretary of State Hillary Clinton - who returned from her week-long three-nation Asia trip from Japan, China and Seoul -- would lead the American delegation.
During Clinton's visit to India, last year, it was decided that the strategic dialogue should be launched between the two countries.
"We have very strong cultural ties to India, so we look forward to the strategic dialogue. It's something that the Secretary and the President (of the US) felt important to elevate the level of our coordination and cooperation. So we look forward to the dialogue," Crowley said in response to a question.
"I think our relations with India have never been stronger. We are talking about the relations between the largest and oldest democracies in the world. We have a great deal in common and we look forward to the meetings next week," Crowley said.
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