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01/28/2008

Mortgage rates plunge to nearly four-year low after Fed tries to make loans cheaper

Mortgage rates plunged to a nearly four-year low just one day after the Federal Reserve
accelerated its effort to lower the cost of consumer loans.

On Tuesday, the Fed's rate-setting committee cut what it charges commercial banks for
overnight loans by three-quarters of point -- the fourth reduction in five months.

By making it cheaper for banks to borrow money, the Federal Reserve hopes banks will
lower the rates they charge all of us to borrow money for everything from homes and cars, to
appliances

On Wednesday our new survey of major lenders found the average cost of a 30-year,
fixed-rate loan -- the most popular way to finance a home -- had fallen from 5.75% to 5.57%
over the past week.

That's the cheapest those loans have been since March 2004. That's 1.25 less than they
cost last summer and 0.75 percentage points less than this time last year.

Our extensive database of the best mortgage rates from across the country shows many
lenders offering 30-year loans for as little as 5.25% with fees of $1,000 or less.

You'd pay $572 a month in principal and interest for every $100,000 borrowed at the
average rate, and $552 if you qualified for a 5.25% loan. (Interest.com's mortgage calculator
can tell you what the payments would be for any loan at any interest rate.)

Those are incredibly reasonable interest rates when you consider what mortgages cost over
the past couple of decades.

Homebuyers routinely paid 7% or 8% during the mid- to late-'90s, and double-digit rates
were the norm throughout the '80s and early '90s.

The only time mortgages were cheaper was in the summer of 2003 when 30-year rates
briefly bottomed out at an average 5.28% -- the lowest they've been since Interest.com (and
its print predecessor) began its weekly survey of major lenders in 1985.

All of the turmoil you've heard about -- lenders going out of business, banks and investors
losing hundreds of billions of dollars, thousands of employees being laid off, soaring
foreclosure rates -- is very real.

But that crisis has really hurt only two types of borrowers:


Those who need a lot of money -- more than $417,000 to be exact.


And anyone with bad credit -- those with credit scores below 620.

Here's why:

Banks and finance companies obtain much of the money they loan for mortgages with the
help of two government-chartered companies -- commonly referred to as Freddie Mac and
Fannie Mae -- or large private investors such as retirement plans, hedge funds and insurers.

Those investors panicked at the prospect of billion-dollar losses because a growing number
of homeowners are defaulting -- primarily borrowers with poor credit who were given
dangerous, adjustable-rate mortgages.

By early 2009 more than 2 million ARMs given to borrowers with credit scores below 700 will
have reset to higher interest rates, pushing payments up by 30% to 100%. That's more than
many of those homeowners can afford.

Almost everyone blames this mess on lax lending standards and a screwed up system that
rewarded mortgage brokers for pushing loans that borrowers had little or no chance of
repaying.

As a result, private investors have stopped providing money for virtually all types of
mortgages.

The best bet for anyone with bad credit is a government-backed loan program. Click here to
learn more about the best loans for subprime borrowers.

Since Freddie Mac and Fannie Mae aren't allowed to buy mortgages for more than
$417,000, jumbo loans have become more costly and difficult to get as well.

The average 30-year jumbo loan has declined from a high of nearly 7.5% this summer to
6.85% in our latest survey. Although this is only the second week it's been below 7% since
July, it's still three-tenths of a point higher than this time last year.

What about ARMs?

Our survey found the average cost for 5/1 ARMs -- a 30-year loan with an initial rate
guaranteed for five years and resetting each year after that -- is now 5.35%. That's
eight-tenths of point less than those loans cost in January 2007.

But the major reason borrowers opt for an ARM is to get lower monthly payments than with a
fixed-rate loan -- at least for the first few years.

With the average fixed-rate loan costing only a little more than the average ARM we urge
you to go for fixed-rate financing. You'll know you've got a loan you can afford and never
lose a night's sleep worrying about higher house payments.

The Federal Reserve is doing what it can to get the country through the subprime mortgage
crisis and avoid a recession by making borrowing cheaper.

It acts as the nation's super bank, lending money to the commercial banks we deal with
every day. When the Federal Reserve lowers its rates, those banks can obtain the money
they need for consumer loans more cheaply.

That doesn't mean rates for all types of consumer loans immediately follow suit, or decline as
much as the Federal Reserve would like.

It's actions have the biggest, most immediate impact on short-term loans. Other factors, such
as inflation and stock market trends, play a larger role in the pricing of long-term debt such
as mortgages.

As a result, the average 30-year, fixed-rate mortgage costs about six-tenths of a point less
than it did in September even though the Federal Reserve has lowered its rates by 1.75
points since then.

But with the central bank expected to continue pushing rates lower right through spring,
there's every reason to expect mortgages will remain a bargain over the next few months.

By Mike Sante
Interest.com Managing Editor
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