Could Mortgage Rates Go Even Lower?

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At least when it comes to low rates, mortgage borrowers have never had it so good. But with millions of homeowners already having refinanced their loans to save hundreds on their monthly mortgage payments, it seems almost inconceivable that rates could go still lower in the future -- especially as the economy apparently starts to pick up steam.

But that's exactly what bond guru Bill Gross foresees happening in the coming months. With help from the Federal Reserve, mortgages could get even cheaper, providing what appears to be increasingly important support to the slumping housing market going forward.

Later in this article, I'll talk about the ramifications of this move for homeowners and investors looking for ways to profit from it. But first, let's look more closely at the Fed's strategy thus far.

The move could come as part of the Federal Reserve's ongoing interventions in the bond market. In an interview with Bloomberg, Gross suggested that as the current "Operation Twist" bond-buying program comes to an end at mid-year, the Fed could change the program by targeting mortgage-backed securities rather than Treasury bonds.

So far, the focus of Operation Twist has been to make sure that the Fed keeps a handle not only on the short-term rates it controls by way of its Fed Funds rate, but also on the longer end of the yield curve. Without both elements, only short-term borrowers would get the benefits of lower rates; mortgage borrowers and others who need to get long-term capital via the debt market could be left facing much higher financing costs as improving economic conditions led to natural expectations of rising rates.

The Fed's moves so far have kept long rates lower. But a new emphasis on mortgage securities rather than regular Treasuries could boost some investments.

First off, any change in which securities the Fed uses for its rate-controlling operations would have a direct impact on the markets it targets. Treasury bonds have traded at historically low rates in recent years as the Fed's numerous quantitative easing programs have pushed up demand for Treasuries. Because Treasury rates are often used as benchmarks for pricing other types of debt, the move has had a collateral impact on financing costs for businesses, municipalities, and a wide variety of other borrowers. If the Fed starts concentrating on mortgage loans, then spreads between mortgage rates and Treasury rates could fall substantially -- either by having Treasury rates rise (as they have recently) or by forcing mortgage rates to drop.

The next obvious winners would be investors in mortgage bonds. One place to find huge mortgage-bond portfolios is inside mortgage REITs Annaly Capital ( NLY ) and ARMOUR Residential ( ARR ) . It's likely that the Fed would concentrate on mortgages backed by Fannie Mae or Freddie Mac , thereby leaving Chimera Investment ( CIM ) and other investors in non-agency mortgage debt with a much smaller impact from the program.

Finally, banks that profit from mortgage activity could once again see another one-time boost to their profits. Just as Wells Fargo ( WFC ) and Bank of America ( BAC ) both reaped big transaction-based profits from the waves of mortgage activity during the housing boom, so, too, would they stand to benefit from homeowners taking advantage of one more chance to refinance at super-low rates. Of course, the long-term impact could be to pull future activity forward, leaving banks with weaker profits down the line. But with the focus on current results among financials, that's probably a trade-off that most banks would be willing to make right now.

It's too early to tell exactly what the Fed will do with rates. But one thing is clear: The economy isn't out of the woods just yet, and a number of options for stimulating the economy are still on the table. If Gross is right and the Fed moves forward with another jolt to the mortgage market, homeowners might get another chance to free up a little extra cash every month.

No matter what happens to rates and your mortgage, you still have to invest in order to build the financial cushion you need. Which stocks should you buy? Get some ideas from The Motley Fool's latest special report on retirement, where you'll find three promising stock picks for long-term investors. It's free, but don't wait; get your free report today while it's still available.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Investing Ideas , Real Estate , Stocks

Referenced Stocks: ARR , BAC , CIM , NLY , WFC

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