Mortgage hunters, lock now; CD buyers, be patient
By Greg McBride, CFA • Bankrate.com

Long-term interest rates have been on the rise. Favorable economic news, the prospect of additional government debt issuance amid ballooning federal deficits and the Fed shying away from buying long-term government bonds have been catalysts for the recent spike. As bond investors have been unwinding positions accumulated in anticipation of deteriorating economic conditions or Fed intervention, bond prices have fallen and bond yields have shot up. Mortgage rates are closely related to yields on long-term government bonds.

The average 30-year fixed mortgage rate has risen from 5.28 percent to 5.99 percent in the weeks since June 11, leaving many to wonder if this spells the end of the mortgage refinancing boom. With the economic horizon brighter than it has looked before, the refinancing rally may indeed be coming to an end.

But we've all been fooled before, as corporate accounting scandals, lead-up to the war with Iraq and concerns about deflation repeatedly pushed bond yields and mortgage rates to new lows. In the absence of external shocks that would push long-term interest rates back down, the days of frenetic mortgage refinancing are numbered.

After all, it has been the repeated lows in mortgage rates that have served as oxygen to feed the refinancing fire, allowing many homeowners to refinance on multiple occasions, each time at a lower rate.

These "serial refinancers" are the first to be displaced from the market, given the sharp increase in rates. And mortgage rates don't need to keep trending higher to threaten mortgage refinancing activity, as rates stabilizing at current levels could be enough to slow refinancing traffic tremendously.

Those who have procrastinated and have yet to refinance should act quickly, in the event that rates continue to trend higher. Sure, mortgage rates are not as great as one month ago, but they remain better than the 6.5-percent average of one year ago and the 7-percent average of two years ago.

With long-term interest rates rising sharply in the past month and the mortgage refinancing boom showing signs of maturity, when will savers start to see an uptick in deposit yields?

Longer-term CD yields have begun to reverse course, a notable event after more than two years of declines, during which yields plummeted to historic lows -- and then kept on plunging. However, the improvement has been slight, with the average five-year CD yield increasing from 2.45 percent to 2.51 percent in the past two weeks.

However, with the yield on five-year Treasury notes rising from 2.63 percent to 2.99 percent in the same time frame, CD yields haven't quite kept pace. While the turnaround itself is notable, it hasn't been sufficient enough to entice investors to lock up money for a multiyear horizon. CDs with shorter maturities will enable investors to take advantage of rising rates by rolling over the proceeds at higher yields in the future.

The yields on short-term CDs have stabilized, but any move to higher yields is on hold, awaiting substantive economic improvement or Fed policy changes. While Alan Greenspan testified before Congress that further interest rate cuts could be employed if needed, he also said that interest rates would remain at current levels as long as is necessary for a return to satisfactory economic performance.

In short, the Fed may or may not cut rates again, but they're unlikely to boost them anytime soon. Such a stance is not likely to foster a significant increase in short-term CD yields in the near future. However, continued economic improvement will ultimately lead to higher short-term CD yields if for no other reason than rendering further Fed interest rate cuts unnecessary.

Yields on liquid investments are still inching lower and will continue to languish. Money market investments are still seeing the effects of the last interest rate cut filter down, with any turnaround coming after yields begin to pick up on short-term CDs and Treasury securities. Higher returns on checking and savings accounts will not be seen in any significant fashion until the Fed begins boosting interest rates, which is not likely until sometime in 2004.

While the sharp increase in long-term interest rates can produce a rapid decline in refinancing activity, depositors eager for higher returns have a long, arduous climb ahead.

Greg McBride is a financial analyst for Bankrate.com.

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