Fed’s announcement last week is aimed at keeping mortgage rates low for a long time and spur housing and economy. The trillion dollar question is – will it actually achieve that aim? It sure faces a lot of hurdles. (By the way if you missed Fed’s announcement, Read the news here reported on this site.) The Fed’s $1.25 trillion of mortgage bond purchases that ended in March 2010, is widely believed to have substantially brought the mortgage rates down. According to Mahesh Swaminathan, Senior Mortgage Strategist at Credit Suisse, the new action by Fed could bring down the mortgage rates even further to 3.25% (as quoted to Wall Street Journal). Lower mortgage rates should help in 2 ways: Lowering the cost of home purchase – A rule of thumb suggests that for every 1 percent drop in mortgage rates effectively lowers the cost of home-buying by 10%. That should help buyers qualify for a bigger home mortgage and buy a larger home. Increase disposable income for Homeowners – By refinancing into lower rates, current homeowners can save several thousand dollars every year. Fed hopes that the homeowners will spend that saving for discretionary purchase , thus buoying the economy. Housing serves as a key channel for Fed efforts to jump-start the economy. The contribution of Housing to job creation and economy can’t be overstated. National Association of Realtors(NAR) estimates:
- For every two homes sold, one job is created.
- Each home purchased pumps up to $60,000 into the economy.
- Home ownership accounts for over $2 trillion of the U.S. GDP.
So what are the hurdles?
Tight Credit Standards– Tight credit guidelines is making several borrowers ineligible to get a new mortgage. For homeowners looking to refinance, lack of equity is a major hurdle.
Benefits not passed on to borrowers – Because of increased regulatory requirement, it takes much longer to close a loan now. That results in higher cost for lenders and they are passing those cost to the borrower. Also, the upcoming increase to Guarantee Fee (Also called G-Fees) will increase the borrowing cost by up to 50 basis points.
This can be seen in the number of mortgage applications taken during last 3 years. According to Mortgage Bankers Association, for 2010, 2011 and 2012 (projected), the annual mortgage production has been less that of 2009.
So while the open end purchase of mortgage backed securities is a bold move (and a desperate one) – it remains to be seen how much impact will that have on housing and economy.