Mortgage rates fall to another modern-day low
By Laura Bruce and Holden Lewis • Bankrate.com

A still-uncertain economic outlook shoved mortgage rates down for the third consecutive week, this time to another modern low.

The benchmark 30-year fixed-rate mortgage fell 9 basis points to 5.66 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.38 discount and origination points.

One year ago, the mortgage index was 6.83 percent.

This latest rate is a modern-day low, eclipsing the March 12, 2003, survey, which gave us a 5.70 percent rate. We have to reach way back to January 1966 to find the next benchmark rate to beat, 5.62 percent.

Prospective home buyers are noticing the latest drop in rates. The Mortgage Bankers Association of America reports that its weekly index of mortgage loan applications, on an unadjusted basis, rose 18.8 percent.

*There's a small asterisk to this week's survey: It is not absolutely comparable to the surveys of the past year, because this week, the benchmark rate is based upon a loan of $165,000. Previously, the benchmark rate was based upon a loan of $150,000. Bankrate.com adjusts its benchmark loan amount annually based upon the Federal Housing Finance Board's calculation of the size of the average U.S. mortgage loan. The board recently announced that the average mortgage loan in 2002 was $163,400. Some lenders may charge a different rate for a different sized loan.

Bankrate.com's other criteria for loans did not change. It asks the same 100 lenders each week to quote the rate they offer to borrowers with good credit, buying an owner-occupied, single-family residential house, with a down payment of at least 20 percent.

Economists express some bafflement about the cause for this latest drop in rates, but have some theories.

Phil Colling, an economist with the Washington, D.C.,-based Mortgage Bankers Association, says at first he was confounded by this week's drop in long-term rates. Mortgage rates tend to move in the same direction as yields on 10-year U.S. Treasury notes, and those yields have dropped this week, even as stock markets remained relatively stable.

"For whatever reason, the bond market is looking for some other set of information before there's going to be an increase in the bond yields, and I'm not sure what that piece of information is," he says. After mulling it over a while, Colling points out that some companies have come out with strong earnings reports, while the Labor Department announced that the unemployment rate rose to 6 percent in April, up from 5.8 percent in March.

"So it's possible that the bond market was focusing more on those jobs numbers and the stock market was focusing more on those earnings numbers," Colling speculates.

Joel Naroff of Naroff Economic Advisors in Holland, Pa., gives a nod to the Federal Reserve, whose rate-setting committee met Tuesday and announced that it was concerned that inflation was too low. To anyone who was around in the late 1970s and early 1980s, the idea that the Fed is worried about low inflation might sound outlandish. But when overall prices remain steady, or actually fall (a condition called deflation), people and businesses have no incentive to buy now. They wait until later to buy, when prices are lower. Lower prices lead to rising unemployment, which leads to lower prices, which leads to rising unemployment.

"First of all," Naroff says, "the Fed's comment about their concern about deflation has really reinforced the view that inflation is hardly an issue at all."

With inflation hidden away, people price bonds on a day-to-day view of what will happen on the inflation front, Naroff says. "As low as rates are, we're getting them even lower at this point," he adds. "A couple of good economic numbers and that'll change, but until that's the case, we're looking at a really noninflationary environment that's actually supportive of these rates right now."

What will make long-term mortgage rates rise by a percentage point or more? "Fairly sustained economic growth, and it has to be more than moderate," Naroff says. "Two-and-a-half to 3 percent isn't going to cut it."

The economy grew at an annual rate of 1.6 percent in the first three months of this year. Many economists expect the economy to exceed a 3 percent annual growth rate in the second half of the year.

With long-term rates settling lower, some homeowners might be tempted to refinance again, or even to refinance for the first time. Novices to the refinancing game often are confused when they try to figure out whether it makes sense to refinance.

First of all, says Ellen Bitton, president of Park Avenue Mortgage in New York City, throw out any rules of thumb that you have heard. Bitton recommends that you do some simple math.

"What I do with my clients is calculate the differential in the monthly payment," she says. In other words, she figures out how much they would save every month by refinancing at a lower rate.

You do this by finding out how much you pay every month for principal and interest. Disregard taxes and insurance. Then compare your current principal and interest with the principal and interest you would pay with the lower rate.

"You then take the closing costs involved and divide it by your monthly savings," Bitton says. She cites the example of a client who refinanced recently from a 7.25 percent, 30-year mortgage to a 5.5 percent, 30-year mortgage. The client saved $581 a month. The closing costs were about $3,000. "You divide the $3,000 by $581, so after the first five months, he's saving money. He's made up his money."

Not everyone will recoup their closing costs so quickly. The key is guessing how long you will stay in the home. If you believe you will recoup your closing costs before you sell the home, it might make sense to refinance.

For people who want to refinance a 30-year mortgage with a 15-year home loan, Bitton calculates how much interest they would save over the life of the loan.

Most clients focus more on their monthly payments and less on the total interest they will pay over the life of the loan, Bitton says.

You make similar calculations when deciding whether to pay discount points to lower the interest rate. You figure out how long it will take to recoup the upfront cost of paying the points, and whether you will be in the house that long.

Sometimes, defying conventional wisdom, it even makes sense to pay points to lower the rate on an adjustable-rate mortgage, says Bob Walters, vice president of secondary marketing for Quicken Loans.

Recently the lender offered a 5/1 ARM (a home loan with an initial rate that lasts five years, and which adjusts annually after that) with no points at 5.25 percent, and a 5/1 ARM with 2.125 discount points at 3.75 percent.

On a $200,000 loan, the discount points would cost $4,250 up front and the borrower would save $178 a month, recouping the cost of the discount points in two years. Over five years, the savings would amount to more than $6,000.

"If you have to refinance or move within 15 or 16 months, you would lose," Walters says. "But most people would say, 'I think I'll be here another 15 or 16 months."