Inflation's on vacation, so mortgage rates fall
By Holden Lewis • Bankrate.com

The benchmark 15-year fixed-rate mortgage fell 13 basis points to 5.14 percent. The benchmark 1-year adjustable-rate mortgage fell 6 basis points to 3.96 percent.

Interest rates reflect investors' expectations about inflation. When they think inflation will rise in the future, interest rates are higher. When investors expect inflation to fall -- or if they find out that they've been overestimating current inflation -- interest rates are lower. This week, investors found out that inflation for consumers was nonexistent in November, at least the way the federal government measures it.

The Consumer Price Index, a broad measure of prices that consumers pay for everything from rent to milk, fell 0.2 percent in November. The core CPI -- excluding food and fuel -- dropped 0.1 percent, the first decline in the core rate since December 1982. That month -- December 1982 -- marked the beginning of an eight-year economic expansion after the long recession of July 1981 to November 1982.

Economists and investors had expected the Labor Department to report a slight increase in consumer prices last month, so the decline in CPI came as a surprise. Yields on U.S. Treasuries dropped (slightly, commensurate with the minor surprise) immediately after the CPI numbers came out, and mortgage rates headed in the same direction.

Declining mortgage rates are good news for home buyers, and home builders feel just as jubilant. Housing starts hit a 19-month high in November, to a seasonally adjusted annual rate of 2.07 million units.

"The key driver for housing has been the favorable interest rate structure, and ongoing solid increases in house values also have fueled demand," says David Seiders, chief economist for the National Association of Home Builders.

Rates aren't the only driver, says Tom Meyer, president of Homebuilders Financial Network, which operates in-house mortgage lenders for large builders.

"As one developer said to me, 'I've never sold a home to an interest rate,' and he's right," Meyer says. "There are much more fundamental drivers that are propelling this market."

One such driver, Meyer says, "is the dream of homeownership, which can somehow sound trite, but it's real and basic and powerful." Affordability is an important factor, too, and Meyer says the ratio of home prices to family income is more favorable now than it was just 10 years ago.