Mortgage Rates Fall. Go Buy a House

Yesterday, the Federal Reserve said it would buy up $500 billion in agency debt (I'll explain this in a minute). This caused the average rate for a 30-year fixed mortgage to fall to 5.5% from 6.4% in just one day. This was the biggest one-day drop in seven years.

In other words, it just got a lot cheaper to buy a house.

Remember That $700 billion Bailout?
Just under two months ago, the $700 billion bailout plan, aka the Troubled Asset Relief Program (aka TARP), was approved with the intention of buying securities riddled with screwed up mortgage assets (e.g. subprime mortgages). This was supposed to convert banks' crap into cash. Instead, the Treasury used most of the TARP money to buy equity stakes in the banks. In other words, the gov't gave the banks cash but also became part owners. This was arguably a better move than just buying bank crap.

Different from the TARP
The Treasury's TARP was designed to buy troubled assets (e.g. subprime mortgages). The Fed's new plan is to buy agency debt securities, which consists of mortgages meeting strict Fannie Mae/Freddie Mac standards. These mortgages are given to people who can actually afford the modestly-sized house they are buying. In other words, these mortgages tend to get paid back.

Shock to the System
The Fed's announcement suggested life would come back into the mortgage-debt markets. This made mortgage-debt investors happy, which made mortgage rates fall.

Great Consequences For the Weak Housing Market
1) Housing prices may stabilize: Houses became more affordable. If you're in the market for a $200k house, then a 5.5% 30-year fixed rate will save you over $40k compared to a 6.4% rate. As bad as things are, there are still a lot of people in the market to buy a home who have been waiting for a more attractive opportunity to jump in. (This is called pent-up demand.) Things just got a lot more attractive.

Housing prices have been plummeting and inventory has been rising. According to the Case-Shiller home price index, prices in 20 major cities fell 17.4% year-over-year in September. This was the fastest pace on record. According to the National Association of Realtors, there was a 10.4 month supply of homes on the market in October. This compares to a 4.5 month average in 2005.

Home-buying activity will bring supply off of the market, which will help housing prices stabilize or even improve.

2) Consumer spending may improve: People can refinance their existing mortgages at an attractive rate. If you're sitting on a 6.4% mortgage on a $200k house, then refinancing at 5.5% would put an extra $115 a month in your pocket. That's extra money you can use to buy stuff, which is great for GDP growth.

Remember: 70% of GDP is consumer spending.

So, buy a house or refinance your mortgage
...if you can afford it, of course. Buying a house will help stabilize the deteriorating housing market. This should ultimately help all of those mortgage-debt issuers, including banks. If the banks' mortgage-debt values stop falling, then they will ultimately be willing to lend more money to consumers and corporations. In other words, this will help unfreeze the credit markets.

If refinancing your mortgage will save you money, then do it. More money in your pocket is means you're more free to buy stuff.

But We're Not Even Close to Being Out of the Woods Yet
The economy is still in terrible shape. I continue to believe things will get much worse before they get better. We will continue to lose jobs and unemployment will rise. This is just part of us becoming a more financially responsible economy.

However, in order for things to eventually get better, the housing market must stabilize and even improve. The recent decline in mortgage rates is a step in that direction.