It was a record-setting week all around, which adds up to good news for mortgage shoppers:
- The Federal Reserve lowered the Fed funds rate to a range of 0% to 0.25%
- It was announced that the Consumer Price Index fell by a record 1.7% in November
- Oil plunged to below $40 a barrel
- 30-year mortgage rates fell to 5.19%, the lowest level on record
While economic weakness is enough to give some home buyers pause, it is important to remember this same economic weakness is creating the extraordinary buying opportunity.
Inflation: The Key Variable
As dramatic as the Fed’s action was, Fed funds rates are obviously far removed from mortgage rates. Probably the key impact of lower Fed rates will be felt more in the long term. By making it very cheap for banks to borrow from the Fed — literally, at little or no cost — the Fed is quietly bolstering profit margins for those banks. Restoring health to the banking system should eventually make loans easier to come by for the average business and consumer.
Of more direct impact on mortgage rates was further confirmation that the economy has flipped from an inflationary environment to a deflationary one. It’s quite a contrast. Just last year, the Consumer Price Index experienced its greatest calendar-year increase in seventeen years, with an inflation rate of 4.1%. By July of this year, year-over-year inflation had increased to 5.5%. Now it stands at around 1%.
Just as the recent surge of inflation was driven by oil prices, the subsequent retreat by inflation has been highlighted by an unprecedented drop in oil, a decline now exceeding $100 per barrel.
Inflation is the key variable leading interest rates lower right now. Interest rates reflect lender outlook for inflation, and their concern over the risk of default. Lender confidence still hasn’t recovered, but lower inflation has given mortgage rates and other market-driven rates of interest plenty of room to fall anyway.
What Comes Next?
While home prices have returned to earth, and mortgage rates are at record lows, the other side of the story is that the recession looks like it is here to stay for a while. As prospective home buyers weigh their options, why shouldn’t they wait until the outlook is just a bit rosier?
The reason is that the exceptional buying conditions that now exist are largely a function of pessimism over the economy. Once the economic outlook gets more encouraging and that pessimism turns to optimism, inflation and mortgage rates may well head higher. After all, with oil having already fallen from north of $140 to south of $40, it’s safe to say most of the decline in oil prices is behind us. Similarly, retailers have been discounting aggressively in anticipation of a weak holiday shopping season — something they won’t do once economic activity picks up. Housing prices may even recover once buyers start coming off the sidelines, though some areas of the country still have serious supply-and-demand issues to work through.
Each individual’s financial security should be the paramount issue in deciding when it is time to buy. If that’s not a problem though, this week’s series of records suggests that conditions may never be much better for buyers than they are now.