—The Mortgage Report: Sept. 8—
- One of the most important factors determining your success with a mortgage is the rate, relative to other rates you could have chosen.
- Over the long run and other things equal:
- The higher your rate relative to other rate options, the worse your odds of success.
- The lower your rate relative to other rate options, the better your chances.
- And, yes, we just told you what you already know.
What’s not so obvious, however, is when to make the tradeoff between upfront rate savings and minimizing risk. If we rely on history for the answer, its message is clear: The closer we get to a sustainable economic recovery, the more you should make that tradeoff.
- And that tradeoff is now being made every day. There are reasons why people with 20% down aren’t flocking to today’s best conventional fixed rate: a 1.75% 3-year fixed. Far more are willing to pay up 6 basis points for the perceived security of a 1.81% 5-year fixed. Is that the right move? It depends partly on how much you value knowing your rate four and five years from now.
- For most, six basis points is too trivial a rate savings to justify the interest risk of a three-year term. After all, if you had to renew in three years at even an 11-bps higher rate, you’d likely lose money in a three-year term—after considering the potential costs to switch to another lender for the best rate.
- Depending on the borrower, six basis points is also insufficient savings to justify the small risk that they won’t qualify in 2023 (when their three-year term matures). Borrowers who can’t get approved at another prime lender are unlikely to get the best deal at renewal.
- We’re in an oddball time historically — a time when the rate differentials between the shortest and longest terms seems strangely narrow. That makes the relative cost of longer-term fixed rates appear cheap.
- This fixed-rate “insurance” is cheap for a reason: the market expects rates to stay low for a long time. But as every bond market pro will attest, the market can’t discount what it doesn’t know about the future.
- In other words, most borrowers must plan for surprises. One way to do that is by paying 5-10 bps more for an extra few years of rate security—as in the example above. That makes ample sense for most people, particularly those who also pick a fair-penalty lender to reduce potential prepayment charges.
- There’s a vocal contingent who’s not fond of bottomless government spending, pandemic or not. “I happen to believe it’s the biggest financial bubble in the history of monetary policy for the whole world,” outspoken former congressman Ron Paul told Kitco News. “The correction is going to be pretty violent, and it’s going to be pretty bad.” By correction, he presumably means interest-rate spike. Former Fed governor Randall S. Kroszner agrees, in a sense, telling Bloomberg that if runaway federal spending continues, “We’re not going to be borrowing at zero [per cent interest] very long.”
- Many believe that interest rates cannot climb materially until North America gets a fully approved vaccine. If that’s true, we’re slowly getting closer to that day. Here’s the latest vaccine tracker from First Trust.