New Low Mortgage Rates: Should You Jump?

Smart Money 12/2/08

In addition to stuffing recipes and football games, another topic is bound to permeate dinner conversations this holiday weekend: the sudden easing of mortgage rates following the government's $800 billion plan to ease consumers' debt load.

The bulk of that government money - $600 billion- will be used by the Federal Reserve to purchase mortgage-related debt held by Freddie Mac (FRE: 0.77, -0.14, -15.38%), Fannie Mae (FNM: 0.82, -0.02, -2.38%), Ginnie Mae and the Federal Home Loan Banks over the next several months. The move eased lenders' fears and swiftly sent mortgage rates plunging by almost half a percentage point-though it didn't take long before they started inching higher again.

Even so, rates are now significantly lower than in recent weeks. On Wednesday, the average 30-year fixed mortgage rate was down to 5.81%, (Today it is 5.25 to $417,000, and 5.625% to $625,000 with 1 point!!!) while the rate on highly popular 5/1 adjustable-rate mortgages clocked in at 5.9%, according to mortgage tracker Bankrate.com. Last week, the average 30-year fixed stood at 6.33%, while the 5/1 adjustable-rate mortgage averaged 6.18%.

The drop is a seismic shift from the incredibly tight mortgage rates of previous months. Borrowers have been anxiously waiting for some rate relief as the specter of declining home prices, rising foreclosures and a low investor appetite for mortgages continued to loom over the housing market. The hope now is that these lower rates will not only spark a wave of refinancing but also home buying, which could help prop up sagging home values, says Keith Gumbinger, vice president of HSH Associates, which tracks rates on mortgages and consumer loans.

Some critics say the Federal Reserve's latest move is far from a cure-all, however. "This still doesn't get to the root of the problem," says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Groups, a consumer advocate. "It's money down a money pit." Without a provision requiring banks to pass along savings in the form of lower rates, or help for homeowners facing foreclosure, the latest bailout is just as limited as the earlier rescue efforts by the government, he says.

While lenders will most likely steer clear of those with low or no credit, homeowners with a solid track record should consider taking advantage of lower rates before it's too late. Here's a primer on what you should know:

QUESTION: Will rates keep going lower?

The recent drop is promising, but it's no guarantee of further declines, says Orawin Velz, associate vice president of economic forecasting for the Mortgage Bankers Association, an industry group. Rates could fluctuate in either direction, depending on how well the government executes its plan. In September, a similar rate plunge occurred after the Fed took control of Fannie and Freddie, but then rates quickly reversed when that move failed to act as a stopgap for industry woes, she says.

QUESTION: Should I refinance now?

"The Fed didn't have a catchy acronym, so I came up with one for them: the 'Really Excellent Financing Initiative,' or RE-FI," jokes HSH's Gumbinger. In other words: Take advantage of those lower rates while you still can.

QUESTION: Should I buy now?

If you've been sitting on the sidelines waiting to buy a new home, this could be a great chance to buy before more buyers enter the market and push home prices higher. The combination of plunging home values and lower-rate mortgages will likely incite many buyers to come out of the woodwork. That means the current fire-sale prices on homes may not last. Of course, that kind of stabilization won't happen overnight, says Velz. "People ready to finance [a home] who were priced out of the market [while rates were higher] should think about getting in," she says.

QUESTION: Will lending requirements loosen?

The Fed's new programs do nothing to broaden the availability of credit. Consumers who have excellent credit will benefit most, says Gumbinger. People with decent credit may see some improvement in their ability to afford a loan thanks to lower rates, but those with bad credit or no credit will most likely be out of luck.