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A look at the mortgage market

Written by A Forex View From Afar on Tuesday, April 08, 2008

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According to the data collected by Freddie Mac, the Primary Mortgage Market in the US, the place where the mortgage big guys (Mortgage Brokers, Mortgage Banks, and Depositories) settle the mortgage conditions is in good shape right now. (At least that what interest rates are saying).

Fed Fund vs 30 years Mortgage Rates

The 30 years fixed-rate loans, the usual loans used for houses, are just starting to feel the benefits from the recent rate cuts. At this point in time, the interest rate charged is around the same value as it was back in 2001-2002, when the rates were at 2%. A loan taken now, over 30 years with a fixed rate is at 5.88% for the primary market.

spread between Fed Fund vs 30 years Mortgage Rates

Unfortunately, a simple calculus shows that the spread between the Fed Funds and the 30 years mortgage grows exponentially when the Fed is in a rate cutting cycle. From a spread of 1% it reaches a top slightly above 5%, a huge gap from the 5.88%.

This shows that the big winners from the rate cut are mortgage bankers in first place, and a long way lower, probably at the end of the line, is the Average Joe. Sadly, this is what charts are showing.

The same things can be observed from studying the 1 year adjustable mortgage (ARM).
Now it bears the same interest rate as it did during the 2001 rate cut, but the big difference comes when the Fed is cutting rates. The same pattern can be observed as in 30 years mortgages; when Fed Funds are targeting lower the spread increases a lot, showing again that the big winners are mortgage banks.

Fed Fund vs 1 year Mortgage Rates

spread between Fed Fund vs 1 year Mortgage Rates

Maybe what the mortgage brokers are doing is a little out-of-line; Why can't they pass on the lower Fed Fund to the rates that Average Joe has to pay? Those rates cut were made for him, not for the big wallet of the mortgage industry.

By keeping the rates higher on mortgages during rate a rate cutting cycle they are just making the Fed's job much harder in trying to re-launch the housing market. Ironically, a better housing market will mean more contracts sold, which will be reflected in their balance sheets. It seems mortgage banks are not ready to accept that, and things may stay that way until they clear out the write-downs on their balance sheets.

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