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Bad economy means low interest rates

One of the most common questions that people ask mortgage professionals is, “What are interest rates today and what direction are they moving?” Most borrowers know that locking in their mortgage rates at the lowest point possible could save significant money over the term of their loans.

Of course, no one has a crystal ball that can see all and tell you without any doubt what the future holds for interest rates. Anyone who claims to have this special insight or knowledge should be viewed with healthy skepticism, as the best and brightest minds in the financial markets are often wrong in their predictions.

Historically, there has been a strong correlation between the interest rate or yield on the 10-year Treasury bond and the movement of daily mortgage rates. Typically, as bond rates go up or down, mortgage rates tend to move up or down with them. The interest rate for the 10-year Treasury bond can be found in the business section of your newspaper or on the Internet. Investors often buy government bonds in times of economic uncertainty as safer investments than stocks, driving yields down. Conversely, when smoother economic times return and bonds are less attractive as investments, interest rates on those bonds go up to lure investors.

The currently low mortgage interest rates are a direct result of investors seeking safer haven after a brutal decline in the stock markets during 2008. Any negative factor that adversely affects the economy typically results in lower interest rates. The lesson here is: Bad news for the American economy is good news for interest rates.

Throughout the mortgage crisis this correlation in rates has remained strong, although the spread between the interest rate offered on the 10-year Treasury bonds and the interest rates on mortgages has increased greatly. This is because of the widely publicized poor performance of many mortgages and the lack of demand for mortgage-backed securities. The federal bailout has helped by guaranteeing the purchase of mortgage-backed securities and keeping interest rates low while increasing liquidity in the markets. Without this intervention, mortgage interest rates would be higher and the spread between the 10-year Treasury bonds and daily mortgage rates even greater.

What is the answer to the original question, concerning the future movement of interest rates? Our current economy is still fundamentally weak with consumer spending and economic growth declining and unemployment and business closings steadily rising. If the nation sees more of the economic pain that 2008 had to offer, interest rates might hold at current levels or decrease. But if the economy improves and the new administration’s stimulus packages spur growth in 2009, mortgage interest rates just might increase.

Brian McMahon, (941) 720-2573, brian@custom-mortgage.biz, is a licensed mortgage broker with more than 15 years of experience and an M.B.A. from the University of Florida.

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