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Low mortgage rates are likely to stay that way

Mortgage interest rates seem to seesaw from week to week but still are drifting down and recently hit several new lows.

The Federal Reserve has said it will continue to intervene to keep rates low until employment rises to a level it considers adequate -- and major players in the financial markets are taking it at its word.

Freddie Mac had an average contract interest rate the week before Thanksgiving of 3.31 percent, and its economists project rates will remain below 4 percent until 2014.

Barry Habib, chief market strategist at Residential Finance Corp., said it is important to look at interest rates from both a short- and a long-term perspective. Short-term there is a lot of "market-moving news" following the election, he said, and the "fiscal cliff" raises fears of recession, which distresses the stock market.

"Wall Street is also worried that the capital gains tax might go up," Habib said. "If the stock market gets edgy, then money, which has to go somewhere, runs into the bond market and rates fall."

He suggested long-term that rates may go even lower and stay there longer than people think.

Even though the Fed said it will continue to keep its foot on the gas, pumping money into long-term investments such as mortgage-backed securities, Habib said, this is becoming less a policy decision than a necessity because "there aren't a lot of short-term alternatives to investing in long-term mortgage-backed securities."

He added President Obama's re-election also makes it more likely that current Fed policies will continue, because even if Fed Chairman Ben Bernanke decides to quit, his likely successor shares his views.

Mitchell Weiss, co-founder of the University of Hartford's Center for Personal Financial Responsibility, said low rates are great for buyers but also have a downside because they can contribute to the difficulty in getting a loan.

"Businesses have to do business to make money, and in the case of banks, they have to lend," he said. "Before the crash, banks were highly leveraged; now they are sitting on all kinds of money and having problems finding places to put it."

While banks have plenty of money to lend, Weiss said, they are bound to become more selective in where they lend it to cut other costs, such as insuring against loss. Banks make money on the spread, or the difference, between the price they pay for money -- now near zero -- and the interest rate they charge consumers. That spread also must cover lender expenses, including the cost of processing the loan, due diligence and losses from bad loans.

The spread also must cover the cost of buying derivatives to protect the bank against rising rates.

Since the cost of money can never go below zero, lenders increasingly face narrow spreads at the same time that low rates almost guarantee borrowers will keep their loans for as long as they keep their houses. So lenders must plan to insure against rising rates for a very long time.