February 9th, 2012 by Mehal Rockefeller
As of now, the housing market offers
some of the lowest refinance rates ever. These exist due to a combination of
the state of the world financial markets and due to the policies of the United
States government. In this season of political change, though, there are a
number of proposals and political realities that could change the atmosphere
greatly for homeowners looking to replace their mortgage with a more attractive
one.
The
Abolition of Freddie Mac and Fannie Mae
Government-sponsored entities,
frequently referred to as the “GSEs,” are currently responsible for 90 percent
of the money that gets lent out as mortgages, based on an article in the New York
Times. When a homeowner gets a mortgage, their lender sells the mortgage to
Freddie or Fannie. Freddie or Fannie then package large blocks of mortgages
into bonds, and sell the bonds on the global financial markets to investors.
Since bonds issued by Freddie and Fannie carry an implicit guarantee from the
U.S. Government, investors will buy them at low rates of interest, making it
possible for mortgages to be made at very low rates.
Politicians ranging from Barack
Obama on the left to Ron Paul on the right have called for the abolition of
these organizations. The problem with them is that they expose the government
to a great deal of risk, since the government is ultimately responsible to bail
them out. In addition, their role in the market distorts the true market for
mortgage debt. If their role is abolished or cut back, private mortgage lenders
will make more, if not all, of the loans in the market. They will likely demand
higher rates of return on safer investments, leading to more expensive refinances
at less attractive terms.
High-Growth
Policies
The biggest threat to the refinance
environment is, ironically enough, good news. Right now, mortgages are cheap
because global investors are buying large quantities of U.S. Government debt at
very low interest rates. In an uncertain global economy, “flight-to-quality”
vehicles such as Treasury bonds or mortgage bonds, underwritten by Fannie and
Freddie and backed by the Treasury, become desirable not because of their
returns but because investors who buy them know that there is an
infinitesimally small risk that they will lose their money.
If the United States government
figures out a way to generate a higher degree of growth, the economy will start
to meaningfully recover. When this happens, the Federal Reserve will have to
raise interest rates to avoid inflation. In addition, investors will become
less interested in “safe” investments, and will buy more stocks, corporate
bonds and other such vehicles. Reduced demand for government-backed mortgage
securities will cause their interest rates to rise, increasing the rates that
mortgage holders have to pay on purchase or refinance loans.
Eliminating
the Mortgage Interest Deduction
Although politicians are generally
loathe to discuss this possibility in an election year, the idea has been
bandied around enough that it may very well return after the election. If it
does, although it should have a negative effect on home values, it will likely
be good for refinance rates.
Right now, when a person buys a
home, they get a portion of their mortgage payment back in the form of reduced
tax liability. For instance, a $250,000 home with a five-percent interest
30-year mortgage for $200,000 carries $9,933 in interest payments in the first
year, with the amount of interest gradually going down as more principal gets
paid off over the 30 years. If the homeowner’s combined federal and state taxes
add up to 30 percent, they would save almost $3,000 in taxes.
Eliminating the deduction would
increase the relative cost of owning a house. According to The Urban
Institute’s paper “Reforming the Mortgage Interest Deduction,” this could shave
ten percent off of a home’s value. Other impacts, though, could be to simply
reduce the number of people who choose to buy homes, or to reduce the size of
homes that people buy. In either instance, this would lead to a reduction in
demand for mortgages, likely helping to keep both purchase and refinance rates
low.
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Senior year student, Isabella Rodriguez, stands between Sick Daddy and Self Portrait
