Mortgage Modifications Threatened by Higher Interest Rates

Mortgage interest rates have spiked during the past two weeks, so is there a need to worry?

The news is unsettling because last August the Federal Reserve announced that it would stop purchasing mortgage-backed securities (MBS) in the open market on March 31, 2010. The thought of one less buyer in the marketplace — one very BIG buyer of mortgage-backed securities — set off claims that interest rates would soar, home sales would slow and the world as we know it would come to a halt.

But, nah, none of that has happened.

  • According to Freddie Mac, the rate for 30-year fixed rate financing stood at 4.99 percent on March 25th. By April 8th the rate for the same financing had risen to 5.21 percent. In both cases there was also a cost of .6 points.
  • In real terms, a $200,000 mortgage at 4.99 percent has a monthly cost for principal and interest of $1,072.42. Raise the rate to 5.21 percent and the monthly cost increases to $1,099.46. That ‘s an increase of $27.04 per month.
  • The interest rate is ridiculously low by historic standards. To give you an idea of how low, the lowest rate in decades was reached during June 2003 when the cost for 30-year financed reached 5.21 percent with .4 points.

We’ve been spoiled by the low rates seen since January 2009. In 2008, for example, Freddie Mac says the average interest level for the year was 6.04 percent — and 6 percent is not much by historic standards. The rate topped 16 percent in both 1981 and 1982.

Mortgage Modifications

However, although the mortgage rate increase has been tiny to this point, it should be pointed out that even miniscule rate increases can have a big impact on mortgage modifications and thus the ability to save homeowners from foreclosure. Here’s why:

Under the government’s Making Home Affordable plan borrowers pay 31 percent of their gross monthly income for housing costs — principal, interest, taxes and insurance. Lenders, however, actually receive a payment equal to as much as 38 percent of the borrower’s gross monthly — the 7 percent differential comes from Uncle Sam.

In other words, as rates rise — even a tiny bit — it becomes harder for borrowers on the cusp of affordability to qualify for the program and more expensive for Uncle Sam if they do.

It’s in everyone’s interest, of course, to hold down foreclosure levels. Fewer foreclosures mean less pressure to push down home values while more foreclosures mean lower home prices generally.

The real worry is if rates increase to 6 percent and 7 percent. These are bottom-of-the-barrel rates by past standards — but in today’s world rates of 6 percent and 7 percent could lead to even higher levels of foreclosure than we’ve been seeing.

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Posted in: Mortgages

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