Underlying all of the controversy surrounding the United States federal budget deficit and the debt ceiling is the simple concern as to how it will affect everyday life for Americans. Although the sun will still rise in the east and trees will still grow new leaves in spring, the financial markets that determine, among other things, what your gasoline costs and what mortgage interest rates will be, are going to change.
Why The Deficit and Debt Ceiling Impact Mortgage Interest Rates
Although mortgage lenders such as KW Wells Fargo can theoretically charge whatever they want for mortgages, the reality is that their ability to set mortgage rates is limited by a number of market conditions. There is a finite amount of money available in the world’s economy for investment purposes. The investors who hold that money look for a fair return for a given degree of risk.
One way to invest that money is by buying US Treasury bonds or bills, which is how the government finances its debt. Another way is to invest the money by buying mortgage-backed securities, which is a roundabout way of lending it to homeowners who want to buy a new home or refinance their mortgage. To attract money, these two borrowers need to offer an attractive rate of return given their relative risk. If the market perceives Treasury bonds to be safer than mortgages, then the mortgages will need to offer a higher rate of return to attract money. This corresponds to a higher interest rate. As perceptions of the risk differential between Treasury bonds and mortgages change, the spread between those two rates can change as well.
However, if the assumption of risk remains the same, then the spread should, theoretically, also not change. Because of this, when Treasury rates go down, mortgage interest rates can also go down. When they go up, mortgages go up.
Short Term Impacts on Mortgage Interest Rates
In the short term, you can likely expect that, although rates may fluctuate, they will remain relatively low. Do not mistake this as a sign that the current level of the federal deficit or the debt ceiling increase is a good thing, though. It is, instead, a reflection of the simple fact that there are few safe places other than the US Government to invest capital. Because of this, Wells Fargo mortgage rates, as well as those for conforming loans which are backed by quasi-governmental agencies like Fannie Mae and Freddie Mac, should remain quite low in the near term.
Long Term Impacts
In the long term, the debt ceiling increase will cause interest rates to go up. To understand why, look at why the debt ceiling needed to be increased — because the Federal Government cannot live within its means. As the government continues to borrow more and more money to finance day-to-day spending, the cost of servicing that debt will become unmanageable. When that occurs, two things can happen.
The first option would be for the government to simply default on its debt and not make a payment. This would cause a crisis of confidence which would cause investors to demand a much higher interest rate to lend to the government because of the increased risk. The higher rates would make it even higher for the government to pay its debts, likely sparking further defaults and even higher interest. Because many residential mortgages, such as those underwritten by KW Wells Fargo, use a guarantee from the US Government to keep their rates low, the government default would hit them even harder than other types of debts.
The second option would be for the government to print more money, causing high inflation and allowing them to pay the debt off with less valuable money.
Because investors typically demand a rate of return on their money that is greater than the rate of inflation, this option leads to higher mortgage interest rates.
In either case, the government’s seemingly uncontrolled spending and debt will lead to higher interest rates over time, making mortgages more expensive.
When to Refinance
If you have any ability to refinance, you should act as quickly as possible.
Although it is likely that it will take a little while for the long term impacts of the debt ceiling increase to outweigh actions that the government takes in the short term to keep interest rates low, there is still no doubt that they will go up. In fact, rates on Treasury securities in 2011 trade in a range that is just about as low as anything that we have seen in the last 100 years, and mortgage refinance rates are equally attractive. If you are contemplating a refinance to take advantage of today’s low mortgage interest rates, odds are that waiting will cost you money.
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