Mortgage interest rates fell in May to their lowest levels in about 50 years. That should have home buyers, homeowners, and Realtors celebrating.
After all, if you have cash, good credit, and equity in your home, you can refinance to a 15-year mortgage at just about 4 percent. A 30-year fixed-rate mortgage can be hand (with cash, good credit, and equity) at less than 4.75 percent.
When I got my first mortgage back in 1989, it was a 30-year loan at 11.75 percent – Almost three times as high as what I could get now.
Clearly, what’s happening in Europe (specifically with Portugal, Ireland, Italy, Greece and Spain) is causing tremors in both the stock and bond markets. Six months ago, economists were predicting mortgage interest rates would be heading toward (or past) the 6 percent level.
But there’s a mortgage land mine being laid for consumers who have loans pegged to the London Inter-Bank Offered Rate, otherwise known as LIBOR.
LIBOR can be a relatively fast-moving interest rate that represents the amount of money banks in Europe charge each other. There are hundreds of thousands of mortgages, school loans, and credit cards that are now tied to this index.
The problem is that LIBOR is rising, which means that the mortgages, school loans, and credits cards that are tied to it will all experience rising interest rates, even as interest rates tied to the U.S. Treasury hit record lows.
How fast is LIBOR rising? Not that fast, but the fact that the interest rate index is rising at all stands in contrast to the U.S. Treasury rate, which is still falling. In recent weeks, a rout in the junk bond market sent world investors seeking the safest possible investment for their money – which is still U.S. Treasuries.
In a recent auction, the interest rate tied to the securities was well below one percent. At that rate, you’re not talking about making money. You’re only talking about preserving principal.
What investors are telling us is that we’re not out of economic distress yet, no matter how well some U.S. retailers are doing.
What should you do if your mortgage loan is tied to LIBOR? If it is tied to LIBOR, you have a variable rate mortgage that will go up or down as LIBOR rises and falls.
If you have a thirty-year fixed-rate mortgage, you don’t have to worry. Your loan’s interest rate fixed and won’t change. But if you have a 5-year adjustable rate mortgage (ARM), which might be tied to LIBOR, you may want to consider locking in on a fixed rate loan.
For some homeowners, that will be easier said than done.
First, can you refinance? The U.S. mortgage market is almost entirely backed by Uncle Sam at this point. In the first quarter of the year, nearly half of all borrowers used an FHA loan, which David Stevens, FHA commissioner, said at a recent industry conference in New York “is the sign of a very sick system,” adding that the mortgage market “is on life support, purely sustained by the federal government.
If you are eligible to refinance out of your LIBOR-indexed loan, you should do it. There will never be a better time to refinance than while investors are jumpy about the economy. Once the economy looks like it is really out of the danger zone, interest rates will start to rise.
If you can’t refinance, either because you don’t have enough equity or the income to support a new mortgage), can you sell your home? While real estate has been selling better (thanks to the now-ended home buyer tax credits), there will likely be a drop-off this summer, as housing inventory rises and demand stalls.
But if you’re in a state where unemployment is lower, the local real estate market may be stronger. Selling your home might allow you to get out from under a loan that’s affordable now, but might not be in a year or two.
Finally, can you rent your home and live cheaper elsewhere? If you can rent your property and cover your expenses, you may be able to offset the amount you’ll lose from a higher interest rate.
Keep in mind if you rent your home today, you may have an impossible time refinancing the loan in the future. Most lenders these days will refinance loans for a homeowner’s primary residence and some second homes, but will consider a rental home as an investment property and may not touch it.
If your school loan is tied to LIBOR, there may not be much you can do except think about consolidating to a fixed-rate loan. If you have credit card tied to LIBOR, consider transferring the balance to a card that is tied to a more stable index.
Some economists and mortgage industry experts believe that we may have these super-low rates for the near term. The key is to plan and be prepared, just in case higher interest rates make a return appearance.