The secondary market overview: From bonds to production ... Low rates and fences
We have ended our perspective on what happened in the secondary markets with regard to the financial crisis. It is time to take a look at what is happening now. The stock market and certain financial measures are telling us that we are in the early stage of a recovery. For example, the Standard & Poor’s (S&P) Index has rallied from below 700 to over 1,000 from the low hit this spring, a swing of over 50 percent. Meanwhile, many are expecting the gross domestic product (GDP) to show a gain for the third quarter according to preliminary numbers that are scheduled for release as we go to press. While the gain is not expected to be strong, that would certainly be a far cry from the first quarter contraction of over six percent.
While gains of 50 percent seem very strong, we must understand that we have a long way to go. The S&P is still approximately 30 percent below the record high hit two years ago. Actually, those of us who are in the mortgage industry do not have to be reminded that we have a long way to go in order to climb out of the recession and financial crisis. With foreclosures still soaring, any housing rebound is expected to take a long time. And with the unemployment rate knocking on the door of 10 percent, a slow recovery will take place in most sectors of the economy.
This continued risk of slow growth seems to have won out most recently with regard to interest rates. With the Fed supporting low rates by spending tens of billions to purchase mortgage-backed securities (MBS), last month, we again hit the historic lows of this spring. Of course the question most everyone is asking is: Where will rates go from here?
Last month, our secondary expert, Eric Holloman, chief executive officer of RateLink, mentioned the likelihood of volatility. With the government spending so much money to support the stimulus of the economy, there is long-term risk of inflation. The price of gold stands as evidence of this belief. However, while there remains a risk of a very slow recovery and even a move back into recession, the risk of inflation is minimized. Hence, lower rates and the potential for volatility that will kick in every time there is a hint that the economy is getting stronger.
One thing we can say is that there is a greater risk that rates will go up as opposed to going down from here. We are not predicting the future of rates. We are just looking at reality. It is really physics. When rates are very low, they are more likely to go up. If rates were at 10 percent right now, we would say they are more likely to go down. I have never been a big believer in charts. I am a fundamentalist. Any catastrophic event that occurs tomorrow can change all the rules. I would never predict that rates will rise tomorrow or next week. But risk is risk, and the risk is greater on the upside because rates are so low.
What does that mean for your production? Well, we certainly are in refinance territory for millions of Americans. Any time rates go down, you have many Americans waiting for them to go down even further. It is human nature to have prospects on the proverbial “fence.” If rates went down to 3.5 percent tomorrow, they would still be waiting. What typically happens is that they jump into the market when rates start going up because they are afraid they have missed the opportunity. And if the increase is volatile, they may miss the opportunity.
Every loan officer faces this dilemma with one or more prospects. The question is: How do we get them off the fence without trying to predict the future of rates? We should be comfortable citing the risk of rates moving up or down. At the same time, we also need to show the prospect not only the benefits of refinancing, but the cost of waiting. The cost of waiting is merely the money they lose by not acting today.
Let’s say that the client would benefit by $250 per month by refinancing today. But the client is waiting for “another 1/4 percent.” That extra downward move in rates, if it comes, would give them another $40 per month in savings according to this fictitious example. The cost for every month they wait is $250. In this instance, let us assume that it takes six months for rates to move another 1/4 percent. In six months, the cost to the client is $1,500. If they successfully refinance at the lower rate, it will take them three years to make up this cost ($1,500 divided by 40). And remember, there is a risk that rates will stay the same. If that happens they will be out $1,500 without any gain. There is also that “greater” risk rates will go up. In this case, the cost would be $1,500 plus the lower gain for as long as they have the mortgage. This cost could wind up being $10,000 or more over 10 years.
One other point … while the prospect is waiting in this market, there is always the chance that the appraised value will decrease and/or the lender will raise the rate because credit requirements have increased. In other words, the cost could increase or the transaction may not go through even though rates did not change. Obviously, missing out on the chance to save “X” dollars per month is even more of a cost.
Yes, there is a cost of waiting, even if rates go down. Remember, rates can stay the same and the cost of waiting goes up. If rates rise, the costs of waiting rises even more. It is important for our prospects to understand the relationship between rates and risks. This is a perfect example of how understanding the markets and rates can help you production.
Dave Hershman is a leading author for the mortgage industry with eight books and several hundred articles to his credit. He is also head of OriginationPro Mortgage School and a top industry speaker. If you would like to stay ahead of what is happening in the markets, visit ratelink.originationpro.com for a free trial.