Where are we; where are we going?

Posted: Jan 05, 2007 12:10 AM

It's a new year, and I have been off work so long (5 days) that I forgot my password to my email account. I know that probably tells me something, however, I am not sure I want to know what it indicates. We start the year with one significant problem brewing in the mortgage arena: short term arms are beginning to go from fixed to variable rates. Many people took short term arms in 2003 and 2004 that were at historical lows. I put out a number of loans to people in 2004 that had interest rates of 3.375% on a three year arm with loan amounts up to $1 million, and 3.875% on a five year arm with the same parameters. This year the three year arms are going to become variables and unless short term interest rates come down (we need the Federal Reserve to start cutting their rates), the variables will be significantly higher in rate and payment. What should be done?

First and foremost, we need to consider the low arms of the past a gift from the gods and realize that we may never see them that low again. Next, be aware that long term fixed rates have come down to rather interesting places (especially the 10 year fixed and the 15 year fixed). These loans are in the middle to high 5% range. They are still significantly higher than your old three or five year arm, but they are well priced as fixed rates. They are worth consideration because of both the interest rate and the shorter term to maturity.

Please note: If you have a five year arm, you should continue paying it off as fast as possible and do not concern yourself with the fact that it will become a variable in two more years. Do not give up this amazing rate because you are worried about what might occur in the next couple of years.

Another option for those who are giving up their three year arm is a straight variable with a low margin: 1% if you will pay a point or in the high 1% range if you wish a loan without points. Although these rates are high now, the Federal Reserve will cut rates sooner or later. When they do, you will reap the benefit for years based on the fact that your margin, the percentage that is added to the index to determine your actual interest rate at every change date, will be low enough to keep you comfortable with low payments until the loan is eventually paid off. Most of these loans come with an interest only option which could be used until the interest rates start dropping. This would keep your payment lower and closer to the payment you were making on your current arm. (Note: if you are adverse to variable loans then this is not for you.) So where are we going and how soon is the trip going to begin? We are going to see lower interest rates in the near future as we are really living in a split economic environment. Those on the higher economic plateau are doing fine while those who haven't made it to the lofty heights are suffering with a stagnant wage market and higher costs for almost everything they need in their daily existence. This would include fuel, health care, insurance, etc, For this group, just trying to make ends meet is getting more and more difficult.

The economy in recent years has been fed by the consumer who was pulling large amounts of equity out of their houses. Then came the real estate slow down and the equity isn't growing nearly as fast in most places and starting to shrink in other areas. Being employment is not a real problem (lack there of would cause house prices to accelerate to the downside), the only stimulus to get housing back on track is lower interest rates. Therefore, as soon as economic numbers start indicating a weaker economy, the Federal Reserve will have to start lowering their short term rates which will have a ripple effect across the mortgage market. As we begin the year, the ten year treasury note remains about 2/3% lower than the "over night" money, thus, we are witnessing an inverted yield curve. This isn't normal in stable economic markets over the long run.

Another point is the States have reaped a windfall of tax revenues from the booming real estate market in the past few years along with the Federal Government. This has come from the profit taking of those who have sold their houses. The States would be hurting again if this was to come to an end.

On Wednesday of this week, January 3, 2007, the economic news of the day was that construction in December was lower while manufacturing, which makes up only about 15% of the nations GDP, was expanding slightly and was experiencing lower prices for their materials needed for production. There was also a report that is a precursor of the Friday's jobs report for December that showed us losing jobs last month and not gaining the 115,000 jobs that has been predicted. We will know today, Friday, @ 8:30A.M. EST. All of these reports and especially the jobs report, if in fact it is lower than the estimate, signal a slower if not slowing economy to the Federal Reserve. This could give some additional credence to the notion that we need lower interest rates to keep the economy going.

I am going to stick with the thought of the Federal Reserve lowering their rates in the first quarter of the year or at least by the April meeting. This will improve the mortgage market and do wonders for the real estate industry. Those who have the luxury of time to plan their next mortgage can spend the first quarter researching the type of loan they want and be in a position to take the best rates of the last several years. If you are thinking of buying a house, I would begin looking now and your timing may turn out much better than you hoped.

The economy maybe slowing but it will not fall "off the wall" unless something that is totally unforeseen occurs. Therefore, you can readily improve your financial position in the near future by not only cleaning up all of your debts but by also anticipating your future needs.

Every time you enter the mortgage market, you are making decisions that can have a lasting effect on your finances. Make sure you do all that is necessary to make it a successful venture.