“THERE WAS A POWER OUTAGE AT A DEPARTMENT STORE YESTERDAY. TWENTY PEOPLE WERE TRAPPED ON THE ESCALATORS.” Stephen Wright …Just like Bonds seem to remain trapped on the “Down Escalator”, causing home loan rates to continue to rise. Last week, hopes for a break away from the miserable downward trend of Bond prices were crushed by a very strong Jobs Report. Remembering that good economic news is bad for Bonds and home loan rates and vice versa…let’s look at what happened.

Although the “whisper number” in the trading pits had predicted a miss for the headline number, the very solid Jobs Report showed new job creations for the month of July at 207,000 – a fair amount over the estimated 180,000 and the biggest number since February. Additionally, both May and June’s numbers were each revised higher by an additional 20,000 Jobs. As if that weren’t enough, Average Hourly Earnings increased by double what was expected, and showed the largest gain in a year! And since Traders had been anticipating much weaker numbers, they found themselves positioned on the wrong side of the market when the news hit. A sharp sell-off caused Bonds to worsen, and home loan rates increased by about .125% on Friday alone.

But the good news is…the strength of the housing market has always been tied to strength in jobs, not interest rates…so Friday’s reports certainly bode well for a strong housing market continuing in the days to come.

AND SPEAKING OF INTEREST RATES…SHOULD “INTEREST ONLY” HOME LOANS INTEREST YOU? DON’T MISS THIS WEEK’S MORTGAGE MARKET VIEW TO UNDERSTAND MORE ABOUT THIS POPULAR NEW OPTION.

An old proverb says, “What goes up…must come down”…but it sure seems that the trend of home loan rates has been nothing but up, up, up of late. Is there anything that can reverse this brutal trend?

Good economic news encourages investors to put their money into the Stock market rather than Bonds, which therefore causes Bonds and home loan rates to suffer. Additionally, positive economic reports on the strength of the economy hints at pending inflation…and as inflation erodes the future value of a Bond, any news of the “i word” is also bad for Bonds and home loan rates. And the news lately has been quite strong – manufacturing is starting to catch some steam, the housing market continues to be hot, consumers are confidently spending money and the job market continues to be strong. The chart below clearly shows the relentless ride lower that Bond prices have experienced for the past five weeks in the midst of all this positive news. When Bond prices go lower, home loan rates move higher, so it’s clear to see that rates have taken a beating.

The week ahead brings the always-interesting Fed Meeting and Policy Statement, where Greenspan and friends are widely expected to raise the Fed Funds Rate by another .25%. Ironically, once the Fed hikes rates, Bond prices may finally stabilize or even improve modestly, as the Fed Funds Rate increases combat inflation. But be on the lookout for any surprises in the statement, which could cause Bonds and home loan rates to react. It would take some excessively negative comments or reports this week to knock Bonds off the “Down Escalator”…but there is a good chance that rates will finally stabilize a bit this week.

Should Interest Only Loans…Interest You?

Just a few short years ago, less than one out of every ten home mortgages taken out were considered “Interest-Only” loans. But today, more than one out of every four loans are Interest-Only mortgages. What is this “Interest Only” anyways, and why all the increased attention?

As the name would suggest, and similar to the way a home equity line of credit works, the only payment required on an Interest-Only home loan is one that will cover only the interest due, usually for the first ten years. No payment is required to be made toward the principle, so the mortgage balance may remain exactly the same as when the loan was taken out. After ten years, the remaining mortgage balance is then paid off over the remaining twenty years of the loan term. Sounds interesting, right? Let’s take a closer look.

Pay Me Now or Pay Me Later

On a standard 30-year Fixed Rate home loan, a $200,000 loan at a 6% interest rate would have a principle and interest payment of about $1200 per month. An Interest Only mortgage generally does carry a slightly higher rate, so by contrast, that $200,000 loan would run around 6.125%…but the payment required would be about $1021 per month, to cover the interest for the first ten years. However, if no payment were made to the principle balance of the loan during the initial ten years, the remaining balance would all have to be paid over the final twenty years of the loan. The new principle and interest payment required would then jump to about $1433 per month. Of course you can choose to pay towards the principle at any time…but most people just enjoy that smaller payment every month.

And the monthly payment shouldn’t be the only consideration. If you were to sell or refinance within the first ten or twenty years, the loan that included a payment toward the principle would have a much lower remaining balance, and therefore give you more equity to help with down payment on a future home…or whatever else you might decide to use that money for. In fact, after ten years of repayment on a typical home loan that includes principle and interest payments, the remaining loan balance would be about $167,000, giving you an extra $33,000 in equity.

So Many Loans, So Little Time

The fixed rate example above is just one of the many Interest-Only options available. Interest-Only loans can also be taken on an Adjustable Rate basis, commonly referred to as ARM’s. With an ARM, the start rate is lower than on a Fixed, but the rate can change and payments may increase over time. An Interest-Only ARM makes the short-term payment savings even greater, but does have an added element of rate change risk.

Another type of Interest-Only loan is commonly called the “Option ARM”, which gives you the option to make a regular payment covering principle and interest, an interest-only payment, or even a payment that does not cover the full amount of interest due. In this case, the unpaid interest is tacked onto the loan balance, which actually increases the outstanding loan amount over time. This is known as “negative amortization”. To go back to our example, our $200,000 loan could have a minimum payment due of $333, which is a whopping $867 monthly payment reduction over a normal loan! It’s little wonder that these loans have become so popular. But the attractive payment comes with a kicker, as you may be adding tens of thousands of dollars to the balance you owe on your mortgage. Meanwhile, you are hoping that you can keep your loan balance neck and neck with home appreciation rates so you don’t end up “upside down” on your home, owing more than it is worth.

Interesting…So Who Is This Loan Good For?

Interest-Only loans are not for everyone, but you can absolutely benefit from these types of loans, if you are wise and disciplined. By properly managing the monthly cash flow savings you gain with an Interest-Only loan, the difference can be invested for greater returns. But wise choices must be made, and discipline must be used, as it would be very easy to let the payment savings simply slide away unnoticed into the checking account every month.

There are others who can benefit as well, like those individuals who expect income to increase over the near term. For example, a spouse may be taking time off from the job to stay home with children, but will return to the workforce in a few years. Others may be anticipating a promotion or completion of schooling a few years down the road. The smaller initial payment required on an Interest-Only loan can provide the opportunity to get into a home with a more manageable monthly payment when it is needed most in the early years, rather than waiting on the sidelines and not purchasing a home at all.

Makes Sense…But Who Is This Not Good For?

Many simply cannot resist the allure of the smaller initial payment, but this loan is not right for everyone. If you are unable to add to your savings on a consistent basis, can’t pay your credit cards off in full, or don’t expect your earnings to increase in the coming years…then be cautious before selecting an Interest-Only loan.

With so many loan options available, it’s always best to talk with a mortgage professional who can clearly explain the different programs available, and help you select the one that is best for YOU.

The Federal Meeting and Policy Statement on Tuesday will certainly attract Traders attention, and the Fed is widely expected to bump up the Fed Funds Rate by another 25 basis points (0.25%). Retail Sales on Thursday is the other potentially high-impact report during the week that could produce a major move in Bonds and home loan rates.

Remember, as a general rule, weaker than expected economic data is good for rates, while positive data causes rates to rise.

Economic Calendar for the Week of August 08 – August 12