2005 Could Spell Relief for Servicers

Most economists expect mortgage rates to rise gradually over the balance of this year as a strengthening economy encourages the Federal Reserve Board to raise rates.

Rising rates should be good news for mortgage servicing managers, even if higher rates slow down loan origination volume. That's because higher rates will bolster the value of mortgage servicing rights and make servicing a more profitable business. Lower portfolio churning should accompany a decline in refinancing activity.

And most economists expect to see only a modest rise in interest rates this year, with the 30-year mortgage rate average somewhere between 6.0% and 6.5% by the end of 2005. While that's higher than the 5.8% average for 2003 and 2004, it's not enough to seriously dampen home sales activity, most industry experts believe.

So that makes 2005 look like a good year for the mortgage industry. Mortgage servicing rights should regain value nicely, even if loan production profits fall from the record levels seen in the last two years.

But there are a number of "what if" scenarios that cloud the forecast, as there always are when talking about the future direction of interest rates.

On the down side, a number of events could lead to a spike in interest rates. While that may not rattle servicing managers and MSR hedge advisors too much, it could be devastating to loan origination business.

Namely, huge U.S. government budget deficits and trade deficits have left the country heavily dependent upon foreign investors to finance our economy. A strong appetite for U.S. mortgage, corporate and government debt from overseas investors is needed to keep rates down. But what if overseas markets lose their affinity for U.S. debt products?

"If that happens, interest rates are going to rise much faster than we are anticipating," said Amy Crews Cutts, an economist at Freddie Mac, during the recent MBA National Servicing Conference.

Barring those unforeseen circumstances, Freddie Mac expects the 30-year mortgage rate to rise 50-60 basis points over the course of 2005, ending the year at roughly 6.2%. A rise of this amount would be a "non-issue" for housing markets, Ms. Crews Cutts said.

Even if the consensus that rates will continue to edge up doesn't pan out, servicers may be in for some relief if rates continue to hover around their current level. Already, refinancing has dipped to less than half of loan applications in recent months.

"We are not seeing the people who forgot to refinance. There is not much of that left out there," Ms. Crews Cutts said.

SNAPSHOT: 30-year Mortgage Rates

Winter 2000 Peak: 8.6%

Fall 2003 Trough: 5.2%

March 3, 2005: 5.8%

Source: Freddie Mac

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