Saving the Banks through Mortgage Refinancing

Mortgage rates are dropping as the Federal Reserve buys up mortgage-backed securities and U.S. Treasury debt. Banks with mortgage units are poised to reap the rewards.

Federal policymakers are throwing out life rafts, and they're camouflaged as ultra-low mortgage rates. Banks will be the beneficiaries, and perhaps homeowners and the retail industry will get a modest boost, too.

Federal Reserve tinkering lowers mortgage rates

The federal government recently announced that it would ramp up its efforts to drive mortgage rates lower, in hopes of stimulating a housing recovery. Those activities involve the purchasing of Fannie Mae and Freddie Mac mortgages, mortgage-backed securities, and long-term Treasury bonds.

The Federal Reserve began purchasing mortgage-backed securities in January. The initial budget of $500 billion was increased to $1.25 trillion in March; the latter amount equates to about 10 percent of U.S. mortgages outstanding. The Fed is also purchasing U.S. Treasury bonds under a plan to buy as much as $300 billion worth of Treasury debt over the next six months.  Bloomberg has reported that the Fed has doubled its balance sheet during the past 12 months via financial asset purchases.

These activities are having the desired impact. Freddie Mac's weekly Primary Mortgage Market Survey indicates that average mortgage rates have dipped from 5.15 percent in early-March to below 5 percent. The lower rates haven't yet stimulated home sales in any measurable way, but they have certainly fueled demand for mortgage refinances.

Crosswinds in mortgage lending

Even though a housing recovery was the primary objective of the strategy, a boom in mortgage refinances could have its own positive impact. Banks that are heavily involved in mortgage lending will earn fee income, and add sustainable mortgages to their books.  This assumes that they continue to rely on recently adopted conservative underwriting practices.

A tight secondary mortgage market may limit refinancing activity, however. Selling mortgages to investors isn't a slam-dunk anymore, and banks may have to hold many of the new loans in their own portfolios. That will restrict the capital available for new refinances.  Despite those crosswinds, the Mortgage Bankers Association estimates that $1.96 trillion in mortgages will be refinanced this year. Purchase mortgages are expected to total $821 billion.

Saving to spend

Homeowners who refinance will benefit by lowering their monthly payments. A mortgage rate reduction of 1 percentage point can reduce a principal and interest payment by about $62 for every $100,000 financed.

Savings of $62 may not seem like much, but it will ease the burden of living in a recessionary economy. Many of those homeowners will also receive another $60 monthly benefit from the Obama Administration's Making Work Pay tax credit. The extra cash will benefit retailers if consumer spending picks up as a result.   

So far, lower rates haven't ushered in a noticeable housing market recovery. But if increased mortgage refinance activity keeps banks from drowning in credit losses, 2009 will be a decent year for the financial sector.