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A wise borrower locks now

By Holden Lewis · Bankrate.com
Tuesday, September 17, 2013
Posted: 4 am ET

If you have been approved for a mortgage and you plan to close within the next few weeks and you haven't locked a rate yet, you should lock. Preferably today, and definitely before 2 p.m. Eastern time Wednesday.

The Federal Reserve's rate-setting Federal Open Market Committee is meeting today and Wednesday, and the big question is whether the group will cut back (or "taper") its purchases of $85 billion a month in bonds. Under the most plausible scenarios, the Fed's decision will have either a neutral effect on mortgage rates or a decidedly bad effect on mortgages, sending the rates higher. I doubt the Fed will say something that would send mortgage rates lower.

Listing the possibilities

The three most-likely things to happen:

  • The Fed reduces its monthly purchases of both mortgage-backed securities and U.S. Treasuries. Mortgage rates probably would rise moderately under this scenario because mortgage bond yields would rise. (I'll explain the link between bond prices, bond yields and mortgage rates in a sec.)
  • The Fed reduces its monthly purchases of U.S. Treasuries but keeps buying $40 billion a month in mortgage-backed securities. Mortgage rates likely would remain about the same if this happens, all things being equal. If anything, there would be some upward pressure on mortgage rates.
  • The Fed stands pat. I think this is the most likely outcome of this week's meeting, and I believe that mortgage rates wouldn't move much on this news.

Two less-likely things to happen:

  • The Fed reduces its monthly purchases of mortgage-backed securities but keeps buying $45 billion a month in Treasuries. My colleague Polyana da Costa calls this the "Fed members get drunk" option. If the rate-setting committee drinks the punch bowl and cuts purchases of mortgages but not purchases of Treasuries, then mortgage rates probably would spike. If you're floating a mortgage rate, this is your worst-case scenario.
  • Fed increases its purchases of mortgage-backed securities. Ain't gonna happen. If it did, mortgage rates probably would fall. Don't count on the Fed doing this, though.

How bond prices affect rates

What I'm about to say is a gross oversimplification to explain a concept.

You've probably read that bond prices move inversely to yields. In other words, when bond prices go up, yields go down, and vice versa. Let me explain why.

A bond is an IOU. Let's say I need to borrow $100 for a year. On a piece of paper, I promise to pay the owner of the paper $105 a year from now. I sell you that piece of paper for $100. That document is a one-year bond with a yield of 5 percent. I borrowed $100 and promised to pay 5 percent interest.

Now, let's say you want to make a quick buck. So you turn around and sell the bond to someone else for $101. That person is entitled to collect $105 from me in a year. Because the buyer paid $101, the yield is closer to 4 percent than the original 5 percent. The bond's price went up (from $100 to $101), so the yield went down (from 5 percent to 4 percent).

The real-world cause and effect

By buying $40 billion a month in mortgage bonds, the Federal Reserve is inflating the prices of mortgage bonds. After all, there's a finite supply of mortgages to buy, and the Fed is adding $40 billion a month in demand. So the monthly purchases send the prices of mortgage bonds upward. And the rising prices for mortgage bonds causes yields to fall. And mortgage rates follow mortgage bond yields.

The Fed's monthly purchases of mortgage-backed securities have been designed to keep mortgage rates down. As soon as the Fed cuts back on those purchases, you can expect mortgage rates to rise. And the Fed might announce a cutback in mortgage purchases Wednesday afternoon.

As I said, lock your rate now.

Follow me on Twitter @HoldenL.

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5 Comments
Holden Lewis
September 20, 2013 at 9:25 am

Ugh! I hate being wrong on this.

ino hoo
September 18, 2013 at 7:33 pm

me thinks you spoke too soon Holden! Ha, Ha, Ha, welcome to the ranks of pundits who try to predict what the fed will do next. I don't blame you my friend. Interest rates are going back down from here. Don't lock until they hit 3.5% on a 30 yr fixed conforming. Tha's my advise.