Daily Mortgage Update

Mortgage rates keep falling this week . Could they have peaked after steadily increasing for two years?

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Our latest survey of major lenders found the average cost for a 30-year fixed-rate loan – the most popular way to pay for a house – fell to 6.65% this week. That’s 0.12 percentage points lower than last week and 0.27 percentage points below the peak of 6.93% the last week of June.

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More importantly it raises the possibility that mortgages may be leveling off after steadily rising for more than two years – and doing it at very reasonable rates.

While rates are still higher than they’ve been in four years, they’re risen less than a point-and-a-half from the record low reached three years ago. And we are certainly no where near the double-digit rates of the ‘80s and early ‘90s.

Interest rates have steadily risen because the Federal Reserve Bank fights inflation by raising interest rates.

With consumer prices rising more quickly than they have in a decade, the Fed has repeatedly raised the interest rate it charges banks to borrow money.

When lenders pass those increases along by raising the rates we pay for mortgages, credit cards, home equity and auto loans, we spend less making it more difficult for them to raise prices.

Anyone buying a home -- or facing big increases in their adjustable rate mortgage or credit card payments, for that matter – is feeling the effect.

A 30-year fixed-rate loan cost just 5.91% this time last year and 5.28% in June 2003. That was the lowest average rate Interest.com (and its ink-on-paper predecessors) has recorded since its weekly survey or major lenders began in 1985.

Although rates on all types of mortgages have declined over the past five weeks, we’re still paying more for other fixed-rate loans, too:

• 15-year loans averaged 6.30%, up from 5.45% one year ago.
• 30-year jumbo loans (for more than $417,000) fell to 6.95% from 7.05% last week -- closer to the 6.8% to 6.9% level it's been hovering at, but up from 6.03% this time last year.

Introductory rates for adjustable-rate mortgages, or ARMs, are rising even faster. Those 30-year loans offer a fixed rate for one to seven years. After that the rate is adjusted each year. If interest rates go up, you pay more. If they go down, you pay less. ARMs with an initial fixed rate for:

• One year, averaged 6.03% last week, and 4.82 % one year ago.
• Five years, averaged 6.36%, up from 5.51% one year ago.

Here’s what that means when you reach for your checkbook if you took out a 30-year, fixed-rate loan for $150,000 at:

• At today’s rate of 6.65%, your monthly payment of principal and interest only would be $962.
• At last July’s rate of 5.91%, your payment would have been $890, or $72 a month less.

At June 2003’s rate of 5.28%, your payment would have been $831 – or $131 a month less.

Mortgage rates could resume climbing this year depending on what happens with inflation – and the inflation-fighting Fed.

It has increased interest rates 17 times, a quarter-point at a time, since June 2004.

Yet the most recent report shows inflation is running at an annual rate of 4.7% for the first six months of the year -- considerably higher than the 3.4% increase for all of 2005.

Higher energy prices are the main culprit. And it’s not just the extra money we spend at the gas pump. The most recent inflation reports show higher energy prices are rippling through the entire economy, pushing up the price of many goods and services.

The overall Consumer Price Index rose a modest 0.2% in June, after climbing 0.6% and 0.4% in April and May. But what’s called the core inflation rate, which excludes volatile energy and food prices, rose 0.3%, just as fast as it did in April and May.

The core inflation rate is considered a better gauge of what’s happening in the overall economy, and it’s shot up at 3.2% annual rate during the first half of the year. It hasn’t grown that fast since the first six months of 1995 and its certainly rising more quickly than what’s widely accepted to be the Federal Reserve’s target of 2% annual growth.

But when the Fed raised interest rates in June, investors and economists were excited because, for the first time since June 2004, the nation’s central bank didn’t say another rate increase was under consideration.

Fed Chairman Ben Bernanke offered more evidence that the bank’s rate-raising campaign might be near an end when he told a Senate committee last month that the economy appeared to be slowing enough to rein in inflation.

Now we’ll just have to see what the Fed’s rate-setting committee does when it meets again Aug. 8.

Most experts expect the Fed will “pause” and not raise rates in August to see if inflation is indeed slowing before deciding to raise rates again in the fall.

If the Fed doesn’t raise rates again this year, the cost of a 30-year fixed-rate mortgage will probably remain under 7%.

If it imposes another quarter-point increase on the nation’s banks, we’d expect mortgage rates to top out at around 7.0% to 7.1% by the end of the year.

Given all of this, here’s our best snapshot of what’s going on in the housing market right now:

Over the past few years sellers could demand higher and higher prices for their homes, and buyers could afford to pay them, because the cost of borrowing money was at or near record lows.

Now borrowing is more expensive. Buyers can’t afford to pay as much as they did last year, or just a few months ago. As a result prices are leveling off or falling in most, although not all, cities.

But if buyers and sellers realize what’s going on and temper their expectations life can go on very nicely.

By Mike Sante

Interest.com Managing Editor

Have a question about your finances? Ask us at editors@interest.com