Will the Fed’s attempt to juice the economy bear fruit?

federalreserve

Last week, the Federal Reserve announced it would attempt to keep mortgage rates low until 2015 to help spur housing and the economy, but the trillion dollar question is, “Will the Fed’s move achieve that goal?”

The Fed’s effort faces many hurdles.

The Fed said it will nearly double its purchases of mortgage-backed securities, bringing the total purchased each month to $85 billion each month, at least through the end of the year. The Fed’s statement indicated there could be larger purchases.

It’s widely believed the Fed’s $1.25 trillion in mortgage bond purchases, that ended in March 2010, substantially lowered mortgage interest rates.

Mahesh Swaminathan, a Credit Suisse senior mortgage strategist, says the latest Fed action could further lower rates, bringing them down to 3.25 percent.

Lower mortgage rates should help in two ways.

By reducing the cost of buying a home – Here’s a rule of thumb: every 1 percentage point drop in mortgage rates lowers the cost buying a home 10 percent. That helps buyers qualify for larger mortgage and a larger home. Lower rates also mean lower monthly payments that could help buyers who couldn’t qualify for a larger payment.

By increasing disposable income for homeowners – By refinancing into a lower rates, current homeowners can save several thousand dollars every year. The Fed hopes that homeowners will spend those savings on discretionary purchases and help prime the economic pump.

The Fed’s effort to stimulate the economy focuses on housing because housing is a cornerstone of the economy. Housing’s contribution to job creation and the economy can’t be overstated.

According to the National Association of Realtors:

• For every two homes sold, one job is created.

• Each home purchased pumps up to $60,000 into the economy.

• Home ownership accounts for more than $2 trillion of the U.S. gross domestic product.

Unfortunately, there are some hurdles to overcome before consumers can benefit enough to inject the economy with the cash it needs to grow.

Hurdles include:

Tight credit standards – Until lenders loosen their vice-like grip on mortgage money, many borrowers will remain unable to qualify for a home loan. Other homeowners looking to refinance to lower rates don’t have enough equity to qualify for a mortgage.

Higher costs passed onto borrowers – Increased regulations have added to the time it takes to close a home loan. Time is money and lenders are passing that cost onto borrowers.

An example is the upcoming increase in the guarantee fee (g-fee) Fannie Mae and Freddie Mac collect from lenders to back the mortgages. The increase will raise borrowing costs by as much as 50 basis points.

The Mortgage Bankers Association says annual mortgage production in each of the last three years – 2010, 2011 and 2012 (projected) – has been smaller than mortgage production in 2009.

The Fed’s plan to increase mortgage backed securities purchases is a bold move, but it remains to be seen how much impact the effort will have on housing and economy.

About the author

A DeadlineNews.Com Contributing Writer Shashank Shekhar is a San Jose, CA-based mortgage lender, author, national speaker and blogger. He has been named to National Mortgage Professional Magazine's "Top 25 Most Connected" and "Top 40 Under-40 Most influential" mortgage professionals. Shekhar's work is featured on Homes.com, Examiner.com, Lender411.com, and his own Lending Expert Blog. Local and national media frequently tap him as an expert mortgage industry source. Connect with Shekhar on Facebook. Contact him at Shashank@ArcusLending.com or call 1.408.615.0655.

Website by imagiNed Web Design