Why the housing market may take a turn for the better (if the government stays out of the way)

It is no secret that the weak housing market is the biggest drag on the economy these days.  MSM is full of homeowners worrying about dropping home values and/or struggling to keep up with payments.  The biggest “culprit” is the adjustable rate mortgage (ARM), which has sent the mortgage payment of many a homeowner skyward in the last couple of years.  Yet what taketh away can also give back, so long as the market is allowed to run its course.

The ARM discussion is personal for yours truly.  We refinanced our home with an ARM three years ago.  Like everyone else, we blithely assumed real estate values would continue to rise, and thus we could “refi” again before the fixed rate period ended.  I assumed that Northern Virginia would be immune from any drop in residential demand due to the expanding Federal government and several counties adopting slow-growth policies.

Needless to say, I got that horribly wrong, and thus, like most Americans with an ARM, my family faced a troublesome future once the adjustable rate kicked in.  So, we planned for said future.  I started looking for a higher-paying job, and found one, but as a consequence I had to scale down my political activity for a while.  This meant I had to “go dark” for a few months, and also pass up a ready-to-launch campaign for my local school board.  Still, it was the right thing to do.

However, my adjustable rate will not take effect until the July of this year.  More to the point, as we were nervously preparing ourselves for the higher payments to come, events in the market completely altered the outlook of not just my ARM, but just about every ARM in the business.

What happened?  Well, as most already know, the housing swoon and Fed Chairman Ben Bernake’s desperate attempts to keep the problem localized to housing took its toll on interest rates.  In fact, interest rates today are dramatically lower than they were even last year - including the interest rates that are used to set the adjustable rates for ARMs.

Now, my story may not be typical, but based on my elemental research, it’s fairly close.  My adjustable rate will be based on what is called the Constant Maturity Treasury Index (in my case, the weekly version).  Since I’ve started tracking it (about a month ago), I have come to the stunning realization that if interest rates stay where they are right now, my adjustable rate will be lower than my current fixed rate (at present, my rate would fall a full percentage point).  Since the overwhelming majority of ARMs use the CMT in some form, this could mean millions of homeowners are due an unexpected windfall over the next few months.  This would also be true of folks who are already in the adjustable phase of their mortgage; in fact, given where the rates were during the last adjustment period, the savings could be even more dramatic.

This could have tremendous implications for consumer confidence (up), economic expectations (up again), home values (at the very least, the plummeting drop would slow down, and perhaps even stop), and of course, the 2008 elections (the GOP could be in a much better position than they are now).  All we would have to do is sit back and let the low interest rates take care of things.

The cynic in me doesn’t see it happening, though.

Lest we forget, there are other players here - namely the mortgage holders.  While most homeowners may not be expecting the rate to drop, the mortgage firms and banks certainly know what’s coming, and will do whatever they must to prevent it from happening.  This in part explains why they were so eager to go along with the voluntary ARM rate freeze last fall.

Still, I’m guessing these firms will look to lock in these rates without relying on ignorant homeowners to do it for them.  So don’t be surprised if some legislation pops up in Congress mandating ARM rate freezes for at least a year, with the full support of “understanding” and “sympathetic” mortgage firms (I’m actually surprised I couldn’t find one already when I started looking over the weekend).  If too many homeowners remain unaware of the bounty that would be headed their way, they will gratefully accept this “stabilizing” idea without realizing what they have allowed Congress to do to them.

So, if you have an ARM like I do, take a look at how the adjustable rate is derived; then track the initial source rate.  Odds are, you have a rate reduction in your future, too, so long as you don’t let the mortgage firms and Congress pull the wool over your eyes.

Don’t let them.