After a brief flare-up in the early part of the summer, mortgage rates have drifted back to extremely low levels in recent weeks. And now, the U.S. central bank is taking steps to ensure that consumers can get their hands on these attractive rates for some time to come. The Federal Reserve Board said today that it would keep its benchmark interest rate as low as zero percent in the face of a still-sputtering economy. It also announced plans to extend by three months its program of buying up debt and mortgage-backed securities from housing finance giants Fannie Mae and Freddie Mac. Government support of this market is a key factor behind today's attractive mortgage rates. And today's move "ensures that rates will remain low for the foreseeable future," says Mike Larson of Weiss Research.
1. Original program: The Fed unveiled its program of buying up debt and mortgage-backed securities from Fannie and Freddie in November 2008. It then expanded the size of the program to nearly $1.5 trillion in March. In the absence of private buyers for these securities, the Fed stepped in to keep mortgage rates low. More affordable mortgage rates help push reluctant home buyers off the sidelines, and more buyers were needed to help absorb the glut of unsold homes that was driving real estate values lower. The program proved successful in bringing down rates. Rates on conforming, 30-year fixed mortgages plummeted from an average of 6.55 percent in the last week of October 2008 to less than 5 percent in early April.
2. Still no private buyers: Although the Fed had planned to end its purchase of Fannie and Freddie securities at the end of this year, private investors—many of whom were burned by housing-related securities—remain reluctant to get back into the market. "There is absolutely no way that the private market is in any position yet to support the entire mortgage market by itself," says Keith Gumbinger of HSH.com. Without demand from the Fed, yields on such securities would have to rise to attract private investors. That, in turn, would push mortgage rates higher.
3. Three-month extension: In order to prevent rates from rising, the Fed moved today to continue buying these securities for another three months, through the end of the first quarter of 2010. The central bank is not, however, putting more cash into the program. Instead, it will reduce its monthly purchases to enable it to stay in the market for a longer period of time. "We are still going to have the 800-pound gorilla in the market," Gumbinger says.
4. Impact on rates: With the program's remaining cash being spread out over a longer period of time, private investors will need to absorb a larger portion of the market each month. This may prod interest rates up a bit from current levels. (Conforming, 30-year fixed mortgage rates stood at 5.16 percent as of yesterday, according to HSH.com. That's down significantly from an average of 5.74 percent in the week ending June 12.) Still, if rates rise from current levels, the extended Fed program will help ensure that they remain in an attractive range for longer than they otherwise would have, Gumbinger says. "If the Fed's demand right now is sufficient to keep rates at 5.25 percent, with the Fed's [decreased] demand, they might go up to 5.38 percent," Gumbinger says. "But they will remain there for a longer stretch of time."
5. Another extension: In addition to extending the program, the Fed is signaling to the market that it is willing to rework its programs in response to changing market conditions, Larson says. As a result, the door remains open to future changes to this program should the housing market underperform in coming months. "They could extend it again if they had to," Larson says. "And [if] the market doesn't improve ... the Fed has no qualms going in there and buying more."