What if mortgage rates go over the fiscal cliff?

Posted by  on Nov 16, 2012

Now that the election is over, attention has focused on the so-called fiscal cliff, a package of deficit-reducing tax increases and budget cuts set to go into effect in 2013.

Experts fear this fiscal cliff could plunge the US economy back into recession. Since today's low mortgage rates have largely been a function of a slow economy, this prospect raises a question -- could going over the fiscal cliff lead to even lower mortgage rates?

About that cliff…

The Congressional Budget Office estimates that the combination of tax increases and lower government spending would push unemployment back up to 9 percent. The National Association of Manufacturers sees even more dire consequences, with unemployment surging to near 12 percent. In either case, a recession seems almost certain.

The irony is that while the fiscal cliff was intended as a deficit-reduction measure, no such benefit may be realized if a shrinking economy hurts tax revenues enough.

...how will it affect mortgage rates?

The fiscal cliff is such a dramatic economic possibility that anyone looking ahead to the prospects for mortgage rates in 2013 has to plan for two contingencies: one if the fiscal cliff comes to pass, and one if it is avoided. Here are some thoughts on what could happen to mortgage rates in each case:

  • If the fiscal cliff comes to pass: While a slow economy has been equated with low interest rates up to this point, don't expect mortgage rates to get much lower if the fiscal cliff brings the recovery to a halt. The Federal Reserve has pretty much exhausted its ability to influence rates. Thus, mortgage rates would probably only drop dramatically if the economy got so bad that sustained deflation took hold -- in which case, good luck finding mortgage lenders in the financial condition to make new loans.

  • If the fiscal cliff is avoided: A credible solution to the budget problem could free the economy to build on the momentum it has shown signs of recently. In that case, the next major move for mortgage rates would most likely be up, not down.

These scenarios suggest that mortgage conditions may be best before the country gets to the fiscal cliff. To put it differently, today's mortgage rates are so attractive that no change in conditions is likely to be favorable.

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