Blogging About Loans: Why rates are not going to get to 4%!

I hate long posts, especially when it's about something like interest rates, but hang with me here because I think this is going to make sense, in simple terms (or as simple as you have heard on this subject).

First you must understand what goes into an interest rate. Let's say a borrower is paying 5% interest. Where does the 5% go?

Approximately 1% of that amount is split between 1) the servicer, 2)FNMA/Freddie Mac, and 3) Wall Street.

1) Servicer earns a portion of the income for maintaining an accounting for each payment made on the loan. Tax and Insurance escrows are managed by the servicer, and a record of principal and/or interest is maintained.

2) FNMA/Freddie are compensated for setting and asssuring minimum borrower and property standards for loans to acceptable for sale as Mortgage Backed Securities (referred to as MBS).

3) And Wall Street earns a portion of the first one percent for facilitating the sale of the MBS. To who? You guessed US! You and me: the public. And at what rate of return? Whatever is left over, or in our example, it would be a 4% return, what is called the "coupon rate".

Thus, to have a situation where interest rates are 4%, would mean we need investors that are willing to accept a THREE percent rate of return. Likely? NOT. Not even with the fed helping!

Speaking of the fed, let's look at what the coupon rates that have been purchased with the 1.25 TRILLION dollars that the fed was authorized to spend: (remember, these are the COUPON rates, not the interest rates! Interest rates would be approx 1% higher)

$42 million was at 3.5%

$151 BILLION at 4%

$268 BILLION at 4.5%

$331 BILLION at 5%

$215 BILLION at 5.5%

$49 BILLION at 6%

$21 BILLION at 6.5%

If you have been keeping a running total, that means the fed has spent just over $1.053 trillion of the $1.25 trillion authorized. Initially is was intended the entire $1.25 trillion would be used in 2009. However, in an attempt to "wean" ourselves off of the injection of the fed's contribution, the remaining $197 billion will be distributed over the first quarter in 2010.

So, what then? What will happen to the rates after the first quarter of 2010? Well.... what were rates PRIOR to fed's participation? 6% to 6.5%.

And will it happen overnight? Probably not.

They'll bounce up and down, just as they always do. But as the fed backs off, the floor / ceiling will go higher. Think of it as a yo-yo.

The yo-yo goes up and down, up and down. Now get on the elevator with that yo-yo still going up and down, up and down. See how the lows get higher, and the highs get even higher?

hmmm... still think 5% interest is too high?

This is my interpretation of a information provided at our office by Barry Habib.