Mortgage rates reverse course, drop sharply
By Holden Lewis • Bankrate.com

Mortgage rates dropped dramatically this week in an abrupt shift following a two-month rise.

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The benchmark 30-year, fixed-rate mortgage fell 11 basis points to 6.31 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 0.31 discount and origination points. One year ago, the mortgage index was 6.32 percent; four weeks ago, it was 6.24 percent.

The benchmark 15-year, fixed-rate mortgage fell 11 basis points to 6.08 percent. The benchmark 5/1 adjustable-rate mortgage fell 13 basis points to 6.17 percent.

Before this week, the average 30-year fixed had risen seven out of eight weeks -- and it remained unchanged during the one week when it didn't go up. That two-month rise followed a six-week period when rates fell every week.

Weekly national mortgage survey

Results of Bankrate.com's Feb. 7, 2007, weekly national survey of large lenders and the effect on monthly payments for a $165,000 loan:

Feds kick off shift in attitude
Bond yields have fallen steadily for a week, bringing mortgage rates down with them. The Federal Reserve kicked things off Jan. 31, when it kept short-term interest rates unchanged and issued a benign assessment of the economy. "Readings on core inflation have improved modestly in recent months and inflation pressures seem likely to moderate over time," the central bank said. Investors paid more attention to that than to the next sentence, which warned that low unemployment could "sustain inflation pressures."

The prospect of falling inflation caused bond yields and long-term mortgage rates to drop. A week after the Fed meeting, the Labor Department announced that workers boosted their productivity by a surprisingly strong amount in the final three months of 2006. Productivity rose by a 3 percent annualized rate in the fourth quarter, better than the 2 percent that many economists had expected.

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Short-term view
Strong productivity gains put a lid on prices, and the prospect of reduced inflation pushes long-term interest rates downward. The productivity report wasn't altogether promising. In 2006, productivity gained by 2.1 percent, the lowest annual rise since 1997. Wages and benefits grew faster than productivity. Viewed from that perspective, inflation doesn't look defeated at all. But bond investors were taking the short view, not the long view. They saw a big jump in productivity for three months, so bond yields dropped and so did mortgage rates.

The drop in rates hasn't produced a legion of refinancers, says Brian Peart, president of Nexus Financial, a mortgage brokerage in Atlanta. "The rates dipped even lower than today a few weeks back, and then they went back up," Peart says.

Indeed, the average 30-year fixed fell to 6.08 percent in the first week of December. Then came that eight-week rise, when the 30-year fixed topped out at 6.42 percent last week.

"There's some refinancing out there, but people aren't actively looking for it," Peart says. Most of his company's business comes from home buyers, not homeowners who are refinancing. Peart adds that "a ton of people" have interest-only loans who might benefit from refinancing before the interest rates on their loans are adjusted upward.

Cash-out refis reign
According to mortgage financing giant Freddie Mac, most refinancers aren't taking advantage of lower rates. They're refinancing to cash out the equity from their homes. In a "cash-out refi," the homeowner refinances the mortgage and gets a new loan for more than the amount previously owed. The borrower gets the difference in cash, to be spent on anything from paying off credit card debt to financing a gambling spree.

Of the Freddie Mac-owned mortgages that were refinanced in the final three months of 2006, 84 percent were cash-out refis. Here's the surprising part: Most people were refinancing to a higher interest rate -- about three-eighths of a percentage point higher.

Amy Crews Cutts, a Freddie Mac economist, speculates that a lot of these borrowers were paying off higher-rate debt, such as home equity lines of credit at 8.25 percent.