Mortgage rate analysis:
Year-end slide bodes well for home buyers and mortgage holders
By Michael D. Larson • Bankrate.com

What a difference a year makes.

Back in January, this year looked like it would turn out to be a true bear market for mortgage lenders and borrowers alike. You name it -- whether it was the super-low unemployment rate, stock market euphoria or supercharged rates of economic growth -- economists and Federal Reserve Board officials were worried about it sparking inflation. Loans got steadily more expensive through May and home buyer despair mounted.

But in a move expected by few, mortgage rates did a complete 180 this spring and began a months-long slide that lasted for the rest of the year. That has brightened this holiday season for mortgage hunters, and should keep 2000 from going down in the history books as a total bust for them.

"The rates were clearly a part of the Fed's inflation policy and the news in interest rates that we had earlier this year to slow the economy down, it took a toll on the mortgage industry," says Wade King, chief executive officer of SouthTrust Corp.'s mortgage division in Birmingham, Ala.

A bumpy start
"The first two months of the year 2000 were as bad as I can remember in the business," he adds. "In addition to the normal seasonal slowdown, you had people sitting on the sidelines because of their concern about interest rates. They weren't too high, but they were higher than they had seen in two or three years."

But thanks to the recent rate rally and a housing market that held up in the face of rising rates, he says, "2000 was still a good year."

The long march higher for mortgage rates began in mid-1999 when the Fed started raising the rates it controls to cool the economy. But officials didn't finish their work last year and continued hiking rates all the way through this May. That pushed 30-year rates to a peak of 8.69 percent -- their highest level in five years -- while driving rates on 1-year adjustable-rate mortgages to 7.37 percent -- their highest level since 1991.

"It was part of the credit cycle -- the credit demands generated by an economy growing very strongly confronting a Federal Reserve that decided it was time to cut back on credit supply," says Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. "Interest rates at all maturities backed up and credit became dear by design."

The market reacts
The cumulative impact of the Fed's rate hikes, higher energy prices and other influences began to take their toll, though, and the economy started to show signs of slowing this summer.

In response, experts began to speculate that the Fed would have to cut rates eventually to keep growth from slowing too much. That prompted long-term mortgage rates, which move in anticipation of future Fed rate changes rather than waiting for those changes to take place, to start falling. Thirty-year rates dropped below 8 percent in mid-August and 7.5 percent in early December.

Short-term ARM rates, which don't change drastically unless the Fed actually cuts rates or is very close to doing so, haven't declined much. But even they have started slipping closer to 7 percent now that it's clear the Fed will have to act sooner rather than later to keep the economy from falling off a cliff.

As a result, the end of 2000 looks much better for borrowers than the beginning.

Long-term rates probably won't hit the 7-percent mark before New Year's Eve. But they're a heck of a lot closer to that magic number than market watchers expected them to be by this point and that could make 2001 a prosperous one for home buyers and mortgage holders.

Check back next week to see what experts have to say about the outlook for next year.