Why are long-term interest rates still so low?

Today's low fixed interest rates have their roots in the downturn in the economy in the days of the "dot-com" crash, and our country's economic response to the attacks on our country on September 11, 2001. Each of these events would have been enough to chill the economy; together they required emergency-level response. Our government, through the Federal Reserve (also known as "the Fed"), dropped the Fed Rate to its lowest level since World War II -- all the way down to 1%.

We can all be thankful that this move accomplished what it set out to do -- by bringing the cost of financing down, many different sectors of the American economy got a boost (just like a bicyclist having the wind at his or her back.) Businesses could expand and produce with lower costs, boosting profits. Home ownership was made easier by low mortgage interest rates, which caused home values to rise dramatically. This in turn provided equity against which home owners could borrow, giving them more cash to put into our economy.

Why put on the brakes?

All good news so far. But our economic recovery has faced (and still faces) two dramatic threats: the rising of costs known as inflation, and the danger of a hot real estate market underpinning so much of our economy's health.

Inflation is a natural result of a hot economy. A growing supply of spending money tends to result in the cost of goods increasing. Recently, the cost of oil has skyrocketed around the globe. This impacts American consumers not only at the oil pump, but in nearly every aspect of our financial lives. Even China (some would say especially China) is facing rising costs of production based on the surge in oil prices -- with rising costs of production comes rising consumer costs, which is inflation.

A response to inflation is to raise interest rates, which can cool some inflationary pressures. So since June of 2004, the Fed has raised short-term interest rates nine times in a row, by a total of 2.25%.

Mortgage interest rates are only loosely determined by rates set by the Federal Reserve -- they're set by traders in the bond market. To them, the Fed Rate is only one piece of a complicated puzzle. Right now the bond market expects the Fed to raise rates three more times in a row, for a total of 3/4 of a percent.

The key to today's low fixed interest rates

But long-term fixed mortgage rates haven't surged by 3/4%, nor have they come up 2.25% since June of 2004. Why not? Because the bond market doesn't believe that our economy is doing as well as those rates hikes would suggest. Let's look at two areas.

1. The "real estate bubble" -- Many people look at how high and how quickly real estate values have increased since 2001, especially on the coasts and cities with a reputation for investment properties. We're not suggesting that there is such a bubble, but the logic is that home values are as high as they are because the next buyer has been willing to pay more than the last buyer did. With a sharp rise in long-term fixed interest rates, one of these days the next buyer won't be willing to pay more, and the seller will have to take a loss to sell. Which means that he or she won't be able to pay as much for the next place -- so there's a domino effect. Real estate values could significantly drop, erasing wealth, causing bankruptcies and certainly drying up the well of home equity from which our country has been dipping so that we could all buy new cars and go on vacations.
2. Job growth -- The economy's recovery has been pretty robust, but job growth hasn't kept up with the rest of the good news. Job growth comes when the economy is creating real wealth (as opposed to simply spending down our assets, which is what happens when we borrow against equity in our homes and spend, rather than invest, that money.) Without stronger job growth, it's too easy to see that low interest rates are critical to our economy not crashing right now.

Your opportunity

All of this translates into opportunity for you. Right now many homeowners are choosing to refinance out of adjustable-rate mortgages ("ARM's") into fixed long-term mortgages, in which payments are fixed for 15, 20 or 30 years. Not long ago, ARM's with low teaser rates seemed looked like a good idea, but what happens when the initial fixed period expires? Will you still be able to afford your mortgage payment? If not, will you be able to sell your house without losing money? And since some ARMs have rates not much lower than fixed-rate mortgages, many are choosing the stability of low, long-term interest rates for themselves and their families.

Get pre-approved for a fixed interest rate mortgage today!