Some see 5 percent interest rates

Potential stock market slide could be good news for home buyers

By ZACH FOX - Staff Writer | Friday, March 21, 2008 9:13 PM PDT ∞

Some mortgage experts are forecasting that rates will soon approach historical lows, flirting with 5 percent, as the economy slogs through what many economists have declared a recession.

Typically, a weak economy and slumping stock market will lower mortgage rates as Wall Street shifts its money from volatile stocks to bonds, which are traditionally more stable, economists and mortgage brokers said.

Over the last few weeks, the leading stock market indicators have seen large jumps and falls in 24-hour spans, leading some mortgage brokers to believe a severe decline is imminent.

"It's almost like the rumbling before an earthquake," said Dan Hopkins, a mortgage broker based in Encinitas. "And if the stock market crashes, bonds look really good, and we should see interest rates drop."

Brokers said they hope that a decline in mortgage rates, coupled with widely expected price declines, could lift the county out of its housing recession.

If prices fall 10 percent from present values and interest rates drop to 5 percent, the typical mortgage in North County will cost about $2,000 per month, down from a peak of $3,400 per month a year ago, according to data from the North San Diego County Association of Realtors and the Mortgage Bankers Association.

"That would be a strong combination," said Alan Gin, an economist with the University of San Diego who thinks 5 percent mortgage rates are possible. "If you can lower the mortgage costs with the interest rates, it might provide some sort of stability as far as the housing market's concerned."

But mortgage brokers expect interest rates to go up in the immediate future after closing at a very low 5.62 percent Thursday, according to a survey by Bankrate.com, an interest-rate tracking site. Hopkins said he agrees rates will increase next week, but thinks that rates could fall to as low as slightly below 5 percent by the end of the year.

Both Hopkins and Gin acknowledge that predicting either the stock, mortgage or housing markets is practically impossible. And there are plenty of varying opinions about the future of mortgage rates.

In contrast, James Hamilton, a professor of economics at UC San Diego, said he expects the market to enter a painful recession, but interest rates to remain near their current levels.

But because this downturn has been wrought by skittish banks after a foreclosure boom and declining home values, the traditionally small difference between interest rates on Treasury notes and mortgages has widened as investors price a risk premium into mortgages, Hamilton said.

"On top of which, I think this particular economic downturn could aggravate that spread," Hamilton said.

Increasing concerns over inflation have also tempered Hamilton's ---- and others' ---- expectations for low mortgage rates.

Investors are less likely to be interested in a low fixed interest rate if decreases in the value of the dollar eat into profits made from interest.

Though recent interest-rate cuts by the Federal Reserve, the nation's central bank, make it cheaper for banks to borrow in the short term, it can exacerbate inflation by devaluing the dollar, economists said.

If inflation occurs at a significant clip, the central bank tends to raise interest rates to encourage saving and stem devaluation. Therefore, if investors perceive inflation to be a risk, they will demand higher interest rates on long-term, fixed-rate loans out of fear that in the future, banks will have to borrow money at a more expensive rate than the interest they are receiving on the mortgages.

So as the Federal Reserve tries to steady the financial market and mitigate any potential recession by offering loans with cheap rates, it can make it more expensive to secure long-term loans, said Daniel Ward, an investment broker with Oceanside-based Integrity Brokerage Services.

That risk, combined with current stock market instability, has led Ward to predict that mortgage rates will fall in the short term, but could shoot as high as 7 percent over the next two years.

"When you have short-term turmoil, they (investors) do buy Treasurys and mortgage rates go down," said Ward. "But what the Fed has done the last few months has stoked the fires of inflation, and that will really spook the bond market. Within a year, people will realize they've gotten really hosed with these bonds."

Contact staff writer Zach Fox at (760) 740-5412 or zfox@nctimes.com. Comment at nctimes.com.

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