Mortgage Interest Rates at 4% Aren't Low Enough—Should the Fed Push Harder?

The central bank may want to do more to help the housing market and stimulate the economy, but it may be out of juice

During the week ending October 6th, the average fixed interest rate on a 30-year mortgage dipped below 4% for the first time, according to Freddie Mac. The Mortgage Bankers Association reported that refinancing applications rose -- by just 1%. These historic rates may not be low enough for the Federal Reserve: reports indicate that some central bankers want to encourage more refinancing and home sales. But have the Fed's efforts reached a saturation point?

The Fed's Next Move?

When the Fed meets next week, the housing market may be on its mind. Its actions announced after its September meeting were squarely aimed at mortgages: it sought to push down long-term interest rates through two policy tweaks. Comparing the week ending October 14th to the week ending September 16th, the Fed's effect on the housing market hasn't been particularly impressive: refinance applications are down 11% and purchase applications are down 6%.

The Washington Post reports that the Fed may humor buying additional mortgage-backed securities to push down rates even farther. At this time, they're reinvesting maturing MBS into new MBS. But a new program would expand their holdings of the mortgage securities. The question is: would it really do much?

Diving Into the Data

Check out the chart below. It shows refinancing applications per the MBA versus the average 30-year prime mortgage interest rate per Freddie Mac. The chart goes back to 2005.*

Applications were relatively low until mortgage interest rates began to fall below 6% in early 2008. Then the financial crisis hit and they plummeted. But they rebounded strongly in 2009, as rates approached and then dipped below 5%. Then applications dropped again. Since that time, we've seen a few mini-booms, but nothing near those 2009 highs. In the meantime, however, interest rates have continued to fall.

At this point, it looks like interest rates would have to break through a significant new bottom barrier to encourage much more refinancing. If the Fed can't manage to slice off another 0.5% or more, Americans aren't likely to respond with an enormous demand for refinancing. Even, then, the result may be modest. At this point, many are relatively content with their already low mortgage interest rates.

Others, however, aren't managing to qualify for refinancing. An initiative announced by the Obama administration this week hopes to change that by allowing underwater borrowers with loans from Fannie Mae and Freddie to refinance. The program, however, is only expected to reach 800,000 people. For the numbers to rise much above that, we'll need to see banks get into the game. Reports indicate that could happen as a part of their foreclosure settlement with the state attorneys general, however.

Home purchases are another story entirely. Despite the ultra-low interest rates, they remain extremely weak. Just last week, mortgage purchase applications hit a new low-point that you'd have to go all the way back to 1996 to match. That's just a week after mortgage interest rates hit an all-time low. Interest rates alone don't appear to be enough to encourage home buying.

Next week the Fed must ask itself whether a new effort to push mortgage interest rates even lower can accomplish much. Additional action may only push down rates a little, failing to spur much additional refinancing or many purchases. Meanwhile, another dose of monetary stimulus could make the Fed's exit even more difficult. It must decide whether or not that potential harm will outweigh whatever economic benefit additional MBS purchases might provide.

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*Note: The MBA asks that I don't publish their index values, but the curve alone should give you a good idea of magnitude.

Image Credit: REUTERS/Rebecca Cook