In congressional testimony yesterday, Fed Chairmen Ben Bernanke said that there are signs that the recession is easing and that the economy is likely to start growing again by the end of this year. In other statements he has talked about “green shoots”, signs of life sprouting up through a barren landscape. One of the green shoots he mentioned specifically was that the real estate market is starting to pick up steam. I can attest to that. Here in the Chicago area the purchase market is suddenly active, and for the first time in ages I am seeing multiple contracts, bidding wars, on the same property. Most of the buyers out there are buying a home for the first time, and a good percentage of what they are buying are short sale or foreclosed homes, so this won’t likely translate into a full blown market recovery any time soon. But these are clearly green shoots. There are some big reasons why first time home buyers are getting into the game now. Property values have come way down, and new buyers can get in at bargain prices. Financing is available through FHA with a low down payment, and that makes it easier for buyers to afford their first home. But a lot of the activity is being spurred directly by Fed action and government incentives. The $8,000 tax credit is a big win for anyone who can qualify, and the biggest incentive may be that interest rates are now at the lowest point since the 1950s. This has helped not just home buyers, but any home owner who has a home and is able to lower their payments with a mortgage refinance. These low mortgage rates have been a big factor in allowing these green shoots to sprout, but there will be an expiration date on these low rates, and at some point rates will head higher.

In normal times mortgage rates are determined primarily by what happens on the mortgage backed securities markets. Mortgage backed securities are pools of bonds backed by home mortgages, and the market was made up of a number of regular market participants including wholesale lenders who would use the market to hedge their rates, and investors who looked at mortgage bonds as safe long term investments. For a long time this was a smoothly operating machine, and by matching up buyers and sellers it kept mortgage rates consistently low compared to other types of bonds. When the whole toxic mortgage mess exploded, this market was thrown for a big loop, and for most of last year we were seeing crazy volatility. It wasn’t uncommon to see interest rates swing by ¼ point in a single day. Mortgage rates were trending up and with the economy in a tailspin, real estate values headed lower. In order for the economy to improve, the real estate market had to stabilize, and home owners and home buyers had to have confidence in the market again. In December, Fed Chairman Bernanke announced a plan to lower mortgage rates by having the Fed buy mortgages directly. The initial announcement called for buying $500 billion in mortgages, but it has since been extended to a total of $1.25 trillion. Since the announcement, the Fed has been the most active buyer in the market, and all the other market players have gotten adjusted to their presence. We still have some volatility, but overall, mortgage rates have consistently moved back and forth in a fairly predictable trend, and even the high points are much lower than they would otherwise be.

With low mortgage rates the Fed has allowed these green shoots to spring up, not just in the real estate market but throughout the economy. When homeowners refinance they have more money in their pocket, and they are more willing to spend it on other things. This increases confidence and sends positive ripples throughout the economy. But the question is, what happens when the Fed stops laying on the fertilizer? So far they have bought just over $400 billion in bonds, and have a lot of purchasing power left. But if the green shoots start spreading and the economy picks up, the Fed is likely to take themselves out of the picture. At some point they will stop buying mortgage bonds and leave the market on it’s own. They won’t do this before the economy, and the mortgage market have stabilized, but when they do leave one thing is certain – mortgage rates will move up. Maybe by a lot. So this is the time to take advantage of the lowest mortgage rates in our lifetime. If you are thinking of buying a new home, or refinancing your current mortgage, don’t wait to long. These rates do have an expiration date stamped on them, and it could be sooner than you think.

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