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March 17, 1995
Mortgage rates set new lows for 1995 this week, trading as low as 8.625% at zero and zero, just about where the market was on St. Patrick's Day a year ago.
There is a new pattern in the data: manufacturing is still going full speed, but consumers have dropped out. To continue to make goods which aren't selling results in inventory accumulation, and forecasts an abrupt slowdown in the economy.
Industrial production rose .4%, and industrial capacity utilization surged .5% to 85.7%. Meanwhile, retail sales fell a half percent in February, and housing starts fell again, down 2.6%, almost 30% below October's level.
The fall in long term rates has done a couple of things: exposed short term ARMs as the bad long term deal they are, and produced a new locking-floating strategy for buyers.
Except as protected by caps, next month everybody with a one-year T-bill ARM will get a payment change notice to 9.125%. One year bills have fallen to a yield of 6.35%, and probably won't go lower until the Fed begins to ease. Add the typical 2.75% margin, round up, and you get 9.125%.
Hell of a deal, there: a solid half percent above today's 30-year fixed rate. This is exactly what's supposed to happen to ARM's, and why lenders offer a teaser on the front end. As the spread narrows between long and short rates, ARMs adjust to a pay rate higher than new 30's. The bill-to-30 spread is still wider than normal, and will narrow some more.
Refinance, you say? If you have a $150,000 loan, a half point saving in rate is $750 per year; after taxes about $500. A refinance costs about $1,500, depending on the reissue rate for your title insurance, and is not deductible. Great: choose a three-year break-even, or continue to overpay.
The fall in long rates has been caused by faith in the persistence of the Fed, and evident economic slowdown. There's a good argument that borrowers should float their rates, particularly if they are more than 60 days from closing. Long locks are expensive, and those with a "float down" provision are even more costly (beware of "free" deals where the cost is hidden in the rate, or re-lock terms).
What if the market doesn't cooperate, and long rates rise? Despite what you just read, above, take out an ARM -- but not a short term one. Do a 3/1 or 5/1, and bet on a window in which to refinance.
This strategy is based on the following thought. Any surprise strength in the economy which results in higher rates would be quickly squashed by the Fed. The squashing exercise would increase the chances of a recession, and drive long rates to lower lows.
When the Fed is on its game, it's win-win time.
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