Friday, August 12, 2011

Does the S&P Downgrade Affect Mortgage Rates?

Everyone is talking about the S&P credit downgrade, and today's winning question by Lise LeBlanc of Keller Williams Executives Realty deals with that subject. Lise receives a $25 Starbucks card and gets her contact information sent to the 6,600 people on our contact list. We also list her contact info on our blog (10,199 visits for the first 6 months of 2011) and on our blog at Active Rain, a real estate blog with more than 210,000 members.

Lise's contact info follows:
Lise LeBlanc, GRI
Keller Williams Executives Realty, LLC

Lise's question is: "How would you explain in simple terms to a first time home buyer the effects the downgrading of the AAA debt rating will have on their new mortgage apart from rates possibly increasing? How much time will they have before rates start going up? What can they do now?"

Here's the answer: Mortgage rates depend on how the mortgage backed securities bond market is trading. If there is a big demand for mortgage bonds, then the rates go down. If there is not a big demand for mortgage bonds, then rates go up.

The biggest purchasers of US mortgage bonds are foreign governments: China, Japan, etc. These foreign governments have lots of cash they must invest in something because they want to earn a return on their money. Mortgage bonds, because they are backed by the US government, are considered to be very safe investments. If the foreign governments did not invest in mortgage bonds, they would have to invest in something else. The alternatives at the moment are not very good, so the demand for mortgage bonds is very strong, which keeps rates low.

The economic situation in Europe is horrible right now, so no one wants to buy Euro bonds. The situation in the rest of the world is not very good, either. So despite the S&P downgrade, US Treasury bonds and US mortgage bonds are still just about the safest investment anyone can make.

It is impossible to say how long rates will stay low. Anyone who tells you that they know where rates are going is just making it up. If they really knew where rates were going, they would not be dispensing mortgage advice. Instead, they would be billionaire bond traders living the high life on Wall Street.
The important thing to keep in mind when talking about interest rates is that macro-economics (the world economy) determines where rates are going. As long as the rest of the world is worse off than the US, rates will stay low. At the moment, the US economy is as good as it gets.

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