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As you probably know, historically speaking, the mortgage rates are still very low. What you may not know is that they are this low due to government subsidies that are about to stop. This means that you need to get into the right mortgage now, before your purchasing power is decreased by higher rates.

Here’s the Situation

At the end of 2008, the Fed started purchasing mortgage backed securities (MBS) from Fannie Mae & Freddie Mac. To date, they have spent about $1.25 Trillion doing so. In other words, the Fed has created an artificial demand (which drives up the price of anything – higher demand = higher prices) to subsidize the mortgage rates.

This graph shows the big spike in prices of the MBS back in late 2008:

Big spike in prices of the MBS back in late 2008. Mortgage Loans in Wisconsin.

The Fed has said on several occasions that the MBS purchase program will stop in the first quarter of 2010.

Just like we saw in the graph above, with the added demand, we will have an immediate and opposite change in prices for the MBS when that artificial demand goes away. This will, in turn, create an immediate and opposite change in mortgage rates as well.

Some would even argue that it could be an even worse swing in the opposite direction because, just like they have created artificial demand, they will eventually have to sell those securities, creating an artificial supply.

Why Lower Prices = Higher Rates

The reason that the mortgage rates go down when the MBS price goes up is because these are fixed-coupon securities. Meaning that no matter what price one pays for the investment, when it matures, it’s face value will be the same.

Naturally, if one pays a lower price for the $1,000-face-value-investment (say $900), they would have a better return on their investment at maturity (i.e. a higher rate of return) than they would if they paid $950 for the same $1,000-at-maturity investment at the same time.

Therefore, as an investor, they want to get the MBS at the lowest price, yielding the highest rate.

Keep in mind that, unless you are the investor in the MBS, you don’t like to see lower prices and higher rates. When you are the borrower, you like to see the investments sold at higher prices so as to yield lower rates for your specific home loan.

This is complicated stuff; if you have more questions, please contact me.

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