Today's Mortgage Rates

Today's mortgage rates are relatively low in historical terms. Back in the 1960s, mortgage rates were comparable with today's mortgage rates. After the oil price shocks in the 70s, inflation and other economic factors drove mortgage rates up as high as 16%-18% in the early 80s, and mortgage rates remained in double digits for most of the decade. Today's mortgage rates of around 6% are low by comparison.

Financial markets, including those which set today's share prices and today's mortgage interest rates, are chaotic systems. This is not to say "chaotic" in the common usage of the term, meaning something with no order to it at all, but chaotic in the mathematical sense, in that the formulas which describe how today's mortgage rates are determined, which are the formulas used to make mortgage rates predictions, have self-referential components.

Predicting today's mortgage rates before today was like predicting the weather - it is impossible to be precisely accurate about today's mortgage rates, and the further in advance you tried to predict today's mortgage rates, the greater would be the margin of error in the prediction.

On the other hand, even mathematically chaotic systems are predictable in broad terms, so at any time in the past it would have been possible to make some statements about today's mortgage rates.

If you think about the weather, you may not be able to predict the top temperature for a given day in July, but you can reasonably sure it will be within a certain range - say, if you live in Miami, between 80 and 95 degrees F, and if you live in Stockholm, between 16 and 25 degrees C.

Just as climate gives a broad indicator of summer top temperatures, economic climate gives a broad indicator of today's mortgage rates. Just as we can make moderately reliable weather predictions, we can make moderately reliable mortgage rates predictions.

Factors Which Make Today's Mortgage Rates Higher: Inflation

So called "real interest rates" are calculated assuming that inflation is zero. To get from the "real interest rate" to the "nominal interest rate", which is what your bank will charge you for your mortgage, you add on the annualised percentage rate of inflation, so today's mortgage rates will be higher if inflation is higher.

If nothing changes whatsoever in the housing market, but something changes elsewhere to create inflation (like, for example, oil prices increase, raising the prices of gas at the pump, heating oil, and anything transported by road), then there will be upward pressure on today's mortgage rates.

Factors Which Make Today's Mortgage Rates Higher: Reduced Availability Of Credit

Financial markets operate on supply and demand. Today's mortgage rates are set by the financial markets. Mortgage lenders generally borrow the money they lend for mortgages, or at least 90% of it. Today's mortgage rates will depend on the supply of money available to lenders, and today's interest rate for the lenders when they borrow it.

Factors Which Make Today's Mortgage Rates Higher: Increased Risk

Apart from the market pricing factors, there is another factor which comes into play in any investment decision - risk. Today's mortgage rates will depend on the overall risk involved in the housing market.

In terms of today's mortgage rates, a key factor is the likelihood of default by home owners, and the bank's chance of getting their money back if a default occurs. The underlying driver of this likelihood is the LVR, or loan to value ratio. This is the average mortgage balance divided by the average house value. Todays' mortgage rates will be influenced my movements in house valuations.

If house values plummet, as they have in some parts of the US, then the default risk for the banks suddenly increases, which means that they will be wanting to raise today's mortgage interest rates.

Factors Which Make Today's Mortgage Rates Lower: Government Intervention

The US Government is an 800-pound gorilla in the financial markets. By issuing Treasury bonds at different interest rates, the government can influence the overall market for money, and thus affect the "real" interest rate, which underlies today's mortgage rates.

Today's mortgage rates take into account the political imperatives as well as the purely economic influences on interest rates. Voters are particularly sensitive to losing their homes in large numbers, and the government is keen to avoid the scenario in which interest rates go up, and more homes are foreclosed, only to be sold into a plummeting market, further worsening the oversupply problem in residential housing.

Everyone - the government, the banks, and the home owners - are in agreement that this is an outcome to be avoided. Based on purely economic considerations one might predict that today's mortgage interest rates are due to rise, but while the political pressure is running high, and in an election year, the government will do everything in its power, however economically irresponsible in the long term, to keep today's low mortgage rates in place until after the November elections. Today's mortgage rates are as much about preventing a total collapse of the housing market as they are about the economic fundamentals.

Predicting where today's mortgage rates will move is more complicated than predicting the weather, because political factors influence today's mortgage rates. This doesn't make predicting changes to today's mortgage rates impossible, of course, but it requires more than just a mathematical model to accurately predict where today's mortgage rates will be tomorrow - it takes a good political understanding as well!

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Reuters

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