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Did mortgage interest rates hit bottom in October?

It's a question which can't be answered because we don't know where rates will be in a few weeks. Or tomorrow. Or next year. That said, it's worth mentioning that we have seen some interesting rate activity during the past few months.

  • In mid-October, Freddie Mac reported that interest levels for 30-year financing reached 5.98 percent, the lowest rate in three decades.
  • In March, the 11th District Cost-of-Funds Index -- the 11th District COFI -- hit 2.653 percent -- the lowest rate since the index has been tracked, a period of more than 20 years. This index is widely used for adjustable-rate mortgages (ARMs), with the result that many ARM borrowers have seen stunningly-low monthly payments while new borrowers have been looking at ARM start rates below 5 percent.
  • In September, the one-year London Interbank Offered Rate (LIBOR) stood at 1.813 percent -- the lowest level seen in years. This index is also used with ARM mortgages.

Even if the market is not at its absolute bottom, rates today are surely attractive when compared to interest levels seen during the past 30 years. Because the cost of capital is low, now is a time to buy with as little down as possible and to refinance for the largest-possible amount. In effect, it's a great time to talk about private mortgage insurance (MI).

While life or heath insurance can be seen as a ghoulish bet of sorts -- if you get ill or die you "win" -- private mortgage insurance is really a financial planning tool. It allows you to borrow more -- and enjoy what you borrow.

To understand how MI works, consider lender needs. You want cash and lenders want to loan you money, but lenders also want to reduce risk. So before they hand over a dollar, lenders check your credit, have the home appraised, and take other steps to reduce their exposure.

One of these "other steps" is a refusal to lend money equal to the value of the property. Instead, lenders will traditionally provide an amount equal to 80 percent of the sale price or the appraised value, whichever is less. Buy a home for $300,000 and lenders will readily put up $240,000 -- if you will supply $60,000, closing costs, and meet all other criteria.

Most people, of course, don't happen to have $60,000 in cash or anywhere near such a sum. The result is that to finance a home borrowers need a loan that represents more of the acquisition cost, something they can get with a guarantee to re-pay the loan by a financially-strong outside party. That's where MI comes in.

Private mortgage insurance does not provide cash to close a loan. Instead, MI companies promise that if the loan fails, they will step in and make good on certain losses. Between the value of the property and the MI guarantee, lenders have little risk and can make loans with 5 percent down or less. And instead of putting up cash they don't have or don't want to spend, borrowers instead pay a monthly insurance premium based on such factors as the amount borrowed, the type of loan (fixed-rate or ARM), and the amount down.

But at this point someone will ask: Why use private mortgage insurance? Why not get two loans, say one for 80 percent of the purchase price and a second mortgage for 15 percent? That way you can borrow just as much, it is argued, and not pay insurance premiums.

A few reasons.

  1. The interest rate for the second mortgage will be considerably higher than the first loan. What you do not pay in mortgage insurance premiums you may well pay in higher loan costs.
  2. If the property increases in value it will be tough if not impossible to get a home equity loan because there are already two mortgages on the property.
  3. That second loan is likely to have a short term, far less than 30 years. That means if you stay in your property you will have to pay-off or refinance the second loan.

Let's look at the third item with an eye toward the future.

We are now at a time with relatively-low interest levels. But what will happen in five or ten years? Will interest rates be higher or lower then today? They surely can't go much lower because there's not much distance before reaching zero. Alternatively, rates can certainly go higher which means you may have to replace today's short-term loans with something more expensive.

But whether rates rise or not, will you qualify for refinancing? Think of all those great jobs during the past five years in such fields as air travel, cable, and Internet development. Think about those fields today. What if rates rise, your income doesn't, and the time comes when you must refinance?

We are now at a moment when rates are surely attractive, a good time to consider buying and refinancing -- and a good time also to prepare for a possible future when rates and economic conditions may not be so wondrous. If you need to borrow, long-term mortgages with fixed-rates and little down may well be one of the best financial options available today.

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