What's Bad For Stocks Can Be Good For Rates

After the most major meltdown in U.S. stock trading since September 17, 2001, markets appear to be recovering this morning.

This should reverse the drop in mortgage rates we saw towards the end of the day yesterday.
To understand why mortgage rates go down when stock markets suddenly fall, we must look at the investor's perspective.

When stocks sell off, investors are suddenly holding cash and so they look for places to park those dollars. Bonds are usually the beneficiary which is why major stock market drops are usually accompanied by large gains in bonds.

Because mortgage rates are born from the prices of mortgage-backed securities -- a type of bond -- days like yesterday are good for home owners and home owners-to-be. As expected, mortgage rates fell late yesterday and have extended those decreases into today.

As stocks recover, however, dollars are pulled from bonds and back into stocks, pushing rates upward.

So far about half of yesterday's gains have already been erased.

(Image courtesy: Wall Street Journal)

Mortgage Insurance Is Tax Deductible in 2007, But With A Catch

Adding complexity to the home financing process, The Tax Relief and Health Care Act of 2006 includes new tax code for homeowners. The act grants itemized deductions for private mortgage insurance (PMI) and government mortgage insurance (MIP) expense premiums paid in 2007.

For all loans originated in the 2007 calendar year, mortgage insurance is tax-deductible provided that two tests are met:

1. The homeowner's household income is $100,000 or less in 2007
2. The home loan is for a primary or secondary residence

For households earning more than $100,000, the deduction is phased out to the tune of 10% per $1,000 of additional income until it reaches 0% at $110,000.

So, if a single person earns $90,000 in 2007 and buys a home using MI, the MI expenses are tax-deductible in 2007. However, there's an catch! Because the new tax code is due to expire December 31, 2007, there is no guarantee that the MI will be tax-deductible in 2008.

Until the tax code changed and before Prime Rate reached 5.25%, MI was a relatively expensive option versus using a second mortgage to help finance a home. Now, the playing field is somewhat leveled for comparison purposes. There are plenty of examples in which MI is a more cost-effective route than a home equity loan and the opposite is true, too.

A full analysis should be performed to determine which course of action is best for you, especially considering the "temporary" status of the tax break.

The Two Methods To Generate Home Equity Are Not Equal

Home equity is created in one of two ways (assuming increasing home value and a non-negatively amortizing first mortgage).

In the first method of creating equity, the homeowner pays down the principal balance on the mortgage. This increases the difference between what is owed on the home and what the home is worth.

In the second method of creating equity, a home's value increases over time. This increases the difference between what is owed on the home and what the home is worth.

Because both methods create equity, homeowners often confuse the two.

In Method #1, the homeowner takes dollars from a paycheck that have already been taxed and places them "on deposit" with the home. The money can only be recaptured when the homeowner sells the home or remortgages.

In Method #2, the home itself creates value. The extra "dollars-on-paper" can be paid as real dollars when the homeowner sells the home or remortgages.

The differences are subtle, but important. Method #1 depletes the homeowner's personal funds to "create" equity and that means that no new wealth is created. Method #2 uses no personal funds at all.

When considering your personal mortgage plan, remember that principal paydown and home appreciation are not equals with respect to building equity.

How Iran's Uranium Enrichment Program Changes Mortgage Rates

In defiance of the UN Security Council, Iran is taking another step towards successfully building a nuclear weapon.

Yesterday, it was reported by the International Atomic Energy Agency that Iran expanded its ability to create nuclear weapons and that it plans to "turn on" at least 1,000 uranium-enrichment centrifuges.

Internationally, this decision creates questions (and fears) about Iran and its nuclear ambition. Traders respond to this by moving their money from risky economies to strong economies. Strong economies better protect and preserve investment dollars when global politics get "scary".

A related strategy is when investors sell small cap stocks in favor of DJIA stocks during a market swoon. The jargon for this buying and selling approach is "Safe Haven" buying.

For mortgage rates, this is a good thing. The United States economy is considered a Safe Haven and investors tend to snap up dollar-denominated securities in the presence of political uncertainty.

More buyers of mortgage-backed securities means that the prices go up. And, as is always the case with bonds, higher prices mean lower yields/rates.

Rates May Slip Lower - If only for a limited Time

Iran has stated that "Suspending uranium enrichment is an illegal and illegitimate demand ... and it will never happen". This, obviously, is fueling the flames of speculation that an international stand-off is lurking. There are many people making broad speculations due to "additional" United States aircraft carriers in the Gulf region.

This kind of international tension is usually enough of a catalyst to frighten markets into pursuing the perceived safety of bonds, but a suicide bomber's attack on a U.S. military base in Afghanistan seems to have added a little extra oomph.

Mortgage-backed securities (and mortgage rate shoppers) may be benefitting from this latest international ambiguity. However, with the number of market reports due Wednesday and Thursday, rates can, likely, be expected to bounce right back as traders will likely take their profits.

Source
Iran won't halt atomic work, snubs big powers
Edmund Blair
Reuters, February 27, 2007 9:19 a.m.
http://www.reuters.com/article/worldNews/idUSL2722031920070227

Federal Reserve Meeting Minutes Released

Well ...
As always, I recommend taking the supermarket approach ...
Meaning - take what you need and leave the rest.

The same applies with the minutes of the Federal Reserve Meeting that were recently released. Below are a few blurbs that caught my attention ...

Residential construction activity remained quite weak late last year, but home sales showed some tentative signs of stabilization. Single-family housing starts declined modestly in December, reversing about half of November's gain.

However, new permit issuance edged up in December after having moved down steadily for nearly a year. Construction in the multifamily sector, which accounts for a much smaller share of new home construction, rose sharply in December to the upper end of the range that has prevailed over the past decade. Sales of existing single-family homes held steady in November and rose in December, while sales of new homes inched up in both months.

Inventories of unsold homes remained considerable although they ticked down in December for the second straight month. The most timely indicators of home prices, which are not adjusted for changes in quality or the mix of homes sold, pointed to small declines.

At its December meeting, the Federal Open Market Committee (FOMC) decided to maintain its target for the federal funds rate at 5-1/4 percent. The Committee's accompanying statement noted that economic growth had slowed over the course of the year, partly reflecting a substantial cooling of the housing market.

In the household sector, the ongoing deceleration in house prices further restrained the growth of home mortgage debt.

However, with the contraction in housing activity expected to abate this year, the pace of economic growth was anticipated to edge back up to a level that was close to the staff's estimate of potential output growth by the end of 2007 and to remain in that same range throughout 2008.

In their discussion of the major sectors of the economy, participants noted that the housing market showed tentative signs of stabilization in most regions.

Mortgage applications for home purchases had risen from their low levels of last summer. Sentiment among homebuilders reportedly had improved in the past few months, and the inventory of new homes for sale had fallen. Nonetheless, participants noted that inventories remained elevated and needed to be worked down before growth in this sector resumed.

Unseasonably warm weather so far this winter complicated the interpretation of recent data, but participants were optimistic that the risk of a much larger contraction in housing had diminished and that the drag on growth from the housing sector would ease later this year.

Now might be a good time to take a gander (slang) at a video I had posted not too long ago here regarding questions that have been raised about the FED's role in the U.S. economy.

Remember to use the supermarket approach.

The Fed's Effects

Mortgage Bonds experienced some interesting movement this week as the Federal Reserve Chairman, Ben Bernanke, testified before Congress, Wednesday & Thursday. The Bond "rally" came amidst Mr. Bernanke's statements that the economy is growing and inflation is moderating.

Mortgage Bonds improved the week by about 30 Basis Points (bp) before being capped by some stubborn overhead resistance. The Consumer Price Index, which shows Inflation at the Consumer level, is set to be released next week. There is hardly any doubt that this will cause the markets to move.

But, in what direction ?