Friday, July 18

Mortgage rates just keep rising. To be more precise, the prices of mortgage bonds continue to plunge, for the third day in a row. When mortgage bond prices fall, mortgage rates rise.

All told, we're talking about a rise in mortgage rates of about 40 basis points this week, with most of the damage coming Tuesday and yesterday. Today, we saw a rise of about an eighth of a percentage point -- before noon.

Mortgage rates are rising faster than Treasury yields, which implies that investors are running away from mortgage bonds. Why? It's a bunch of little things, mortgage banker Dick Lepre tells me, but mostly it comes down to concerns about falling house prices and growing numbers of foreclosures. Investors demand higher mortgage rates to compensate for the risks.

CARROTS AND STICKS: This week, I wrote about IndyMac and the FDIC's plan to experiment with short refis. A short refi is when you owe more than the house is worth and you can't afford the monthly payments, so some of the debt is forgiven, and you refinance for a smaller amount, into a loan that you presumably can afford.

I wrote that I was "all for experimenting with short refis for owner-occupants who are in genuine financial hardship."

A reader named Bob replies: "I don't agree with this. What about those of us who did the right thing and can afford our houses? My house has gone down in value at least 15 percent since we purchased last year. Why should I be penalized for purchasing a house that I can afford, while my neighbor gets to refi into smaller loan? I'd like a short refi, too. I could use a couple extra hundred dollars each month."

Despite all the technical potholes in the road to short refis, their future ultimately is a political question. Bob frames one side of this political debate well. I agree with him, and with people on all sides of this issue. I doubt I'm alone in my ambivalence, and that's going to make this issue hard to resolve.

I would like to get away from talking about punishment, though. Bob asks, "Why should I be penalized for purchasing a house that I can afford?" I don't think anyone is penalized for buying a house that they can afford. Bob lives in a house that he can afford, and that seems like its own reward, and not a penalty.

When a neighbor can't afford his mortgage, and he gets a short refi that enables him to stay in the house, I don't see that as a penalty imposed on the other neighbors. I don't think it's any of the neighbors' business. It doesn't affect them, except from the standpoint that they don't have to live next to a house in foreclosure.

Yes, I would like to save a couple hundred extra dollars a month, too. But it's no skin off my nose if my neighbor gets a break like that and I don't.

In large part, I'm playing devil's advocate here -- because I simultaneously agree with the counterargument I just made, and with Bob's argument. If you forced me to jump onto one side of the fence, I suppose I'd hop on my side. I'd say that your neighbor's personal finances are none of your business.

Anyway, the real winner isn't the homeowner who gets a short refi and a lower mortgage payment. The winner is the person who sold that house at an inflated price. Why don't people want to penalize that guy?

UP AND AWAY:Mortgage rates are rising fast -- almost a quarter point compared to yesterday. In a case of terrible timing, our survey here at Bankrate says that rates fell in the last week. The same happened with Freddie Mac's oft-cited survey.

In Bankrate's weekly sample, the average rate on a 30-year fixed fell 6 basis points this week, to 6.42 percent. Freddie Mac has the 30-year fixed down 11 basis points, to 6.26 percent.

If Bankrate's survey had been conducted yesterday the afternoon rather than in the morning, it would have shown a modest increase of 5 basis points to 10 basis points. If it were conducted today, it would show about a 25 basis point increase from a week ago.

Investors appear to be worried about credit quality of mortgages -- in other words, whether payments will come in as expected. As they buy mortgages, they demand higher rates to compensate for the risk they're taking.

To illustrate what I'm talking about, let's look at the yields paid on 10-year Treasury notes compared to the required net yields that Freddie Mac requires on the mortgages that it buys. Freddie's required net yields are a useful stand-in for mortgage rates.

At the beginning of the month, Freddie's required net yield was 6.2 percent, and the 10-year Treasury yielded 4.01 percent. This afternoon, Freddie's required net yield is 6.29 percent, and the 10-year Treasury's yield is the same as 16 days ago -- 4.01 percent. The difference between the two yields is greater -- 2.28 percentage points now, compared to 2.19 percent at the beginning of the month.

Whenever you hear someone on TV talk about "widening spreads," this is the phenomenon they're talking about. Usually they're not comparing 10-year yields to mortgage rates; they're comparing 10-year Treasury yields to 2-year Treasury yields, or Treasury debt to corporate debt. Same concept, though.

I expected yields to narrow when the feds announced that they would lend money to Fannie or Freddie if needed. Just the opposite has happened. It's an indication that investors continue to worry about the mortgage market and Fannie's and Freddie's roles in it.

OUT OF THE BARN: In an article this week, I explain how the Federal Reserve banned stated-income subprime loans, long after stated-income loans dried up and subprime mortgages were swallowed up by the FHA.

THE TREND:A reader asks The Question: "Do you expect the 30-year fixed mortgage rates to rise or fall over the next week based on the Freddie and Fannie news (or other mortgage/bond news)? Obviously, I'm preparing to lock a mortgage and I'm trying to get the best-acceptable rate for my family."

When surprising events shake the markets, I think it's best to hunker down. Rates were volatile late last week, and are calmer this week, but that's not necessarily permanent. A big bank was shut down, and a big bank could possibly shut down this Friday. A regulator might get caught speaking candidly near a microphone. We just don't know. In interesting times such as this, lock the rate if you find it acceptable.

I wouldn't guess where rates are headed in the next week. Times are too crazy.

By the way, there has been little change in mortgage rates today, compared to the end of the day yesterday.

INDYMAC REOS: Another reader writes: "A friend found a house that is in foreclosure and owned by IndyMac Bank. They were going to make an offer on the house. How might this affect them? I'm guessing they wouldn't hear anything back from IndyMac for a while if they made an offer. My wife and I purchased a house from IndyMac a few months ago. Would we be affected by any of this?"

Like you, I'm guessing that your friends won't hear anything back from IndyMac for a while. If you're among the hundreds of thousands of people who mail mortgage payments every month to IndyMac, keep sending those checks. The account probably will be transferred to another servicer someday, and you should get plenty of notice.


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