Falling Loan Rates Rekindle An Unexpected Refi Market

With the economy slowing faster than many economists had expected, mortgage rates have dipped to their lowest point since May 1999 and sparked an unexpected - and much needed - refinance boom.

Some observers, however, said the refinance wave will not last beyond spring. Mortgage lenders and banks should take advantage of the sudden escalation but not count on the business for the long term, they said. "It's a window of opportunity that will close probably sometime in the next three to six months," said Mark Zandi, chief economist at Economy.com. "The Fed is going to start easing aggressively, the stock market is going to stabilize, and the economy is going to make it through this without experiencing a recession."

Less than two month ago several industry analysts and economists predicted that rates, which had peaked in May and have slid steadily since, would hover around 7.5% before heading back up to 8% by yearend, and would stay there for the balance of next year.

Yet in the week that ended Dec. 22, the 30-year fixed rate plummeted to 7.17%, according the Freddie Mac's weekly survey, reaching its lowest point since May 14, 1999.

Moreover, refinancing accounted for 37.2% of the applications in the latest week, according to the Mortgage Bankers Association, up from 13% in May.

Though Mr. Zandi said the refinance opening offers a strong opportunity for lenders to drive up origination volume, they should not take the development as a signal to expand aggressively or hire large numbers of employees to handle new business, he warned. "If they do that, they will probably get caught with their fingers in the window as it closes," he said.

Explaining why mortgage industry predictions were so off the mark in November, Mr. Zandi said the stock market caved and the economy hit a wall in a way that no one expected. "The economy hit an air pocket," he said. "I don't know if it will come crashing down, but it certainly fell."

Doug Duncan, chief economist at the mortgage trade group, said that even though he was caught a bit off guard by the speed at which the economy has slowed, his current rate forecast for next year, of about 7.5%, still looks reasonable - depending on the economy's performance in the fourth quarter this year and the first quarter next year.

"If we actually see negative growth, however, then we probably would revise those numbers down because we think rates would fall a little lower than anticipated," he said.

Nonetheless, Mr. Duncan said if rates stay below 7.25% for any length of time, the market is likely to see a substantial volume boost on the refinance side. The association's current outlook for next year puts refinances at 26% of the total origination volume - currently pegged at $1.16 trillion - bringing in more than $300 billion.

"We may have to back that off a little bit if the economy slows so hard that it cuts into the purchase side of things," he said. "That's where our forecast may be optimistic."

Mr. Zandi said the crash in the equity markets has set off a "flight to quality," leading to a voracious appetite for Treasury bonds. Currently the 10-year bond offers about 5%, he said, and that has helped to break down fixed mortgage rates.

"That's why we're hovering around 7% for mortgage rates when everyone thought it would be at least 50 basis points or 100 basis points more," he said, adding that current rates appear to be artificially low because of the heightened level of fear among investors.

He said that in the next six months, however, money will start flowing back into the equity market and other parts of the bond market, and then Treasury yields will rise, taking fixed mortgage rates with them.

Mr. Zandi agreed with Mr. Duncan, saying 10-year Treasury bonds should hover around 6% in the long run, and fixed mortgage rates should be somewhere between 7.5% and 8%.

The main reason for the short-term duration of the current low rate environment and burgeoning refi market lies with the anticipated actions of the Federal Reserve.

Both Mr. Zandi and Mr. Duncan said they believe the Fed will drop rates in January, perhaps as much as 50 basis points, and at least once more later in the year.

"Everybody feels comfortable with the idea that the Fed will essentially bail us out and ease aggressively enough and in a timely enough fashion that they forestall a serious erosion in confidence and economic conditions," Mr. Zandi said.

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