Mortgage rates are being pressured higher this morning in response to a higher open for stocks.  Stocks and bonds compete for the same investment dollar so when the equity markets rally it is often at the expense of bonds.

The US Treasury is set to deliver $21 billion in 10-year notes later this morning.  Yesterday’s $40 billion of 3-year notes went well.  The final leg of the treasury’s biweekly auction comes tomorrow when they’ll auction off $13 billion in 30-year bonds.

There is not much in the way of economic data today so we’ll continue to watch the stock market for leadership.  I don’t feel there is a compelling reason not lock so long as 30 year fixed prime rates are below 5.00% (5.01% APR).

Current outlook: locking bias

If you are a stock market fan then the article is worth a read.

I noted in yesterday’s rate update that public support for Greece’s austerity plan pressured rates higher because of an unwinding in the “flight-to-quality” trade.  However, this morning that trade is gaining traction due to a surprise announcement by Fitch Ratings Service in which they raised concern over Portugal and the United Kingdom’s fiscal health.  These concerns are creating demand for relatively “safe” US debt which is helping yields.

Later this morning the US Treasury will auction $40 billion in 3-year notes.  The results of this auction can shape the direction of interest rates.  Tomorrow the US Treasury will auction $21 billion in 10-year notes and on Thursday we’ll get $13 billion in 30-year bond supply.

Rates remain very attractive so we’ll maintain a locking position.

Current outlook: locking bias

Over the weekend French President Nicholas Sarkozy publicly voiced France’s support for Greece as it tries to navigate its way out of the financial mess they find themselves in.  His support is likely to take some more wind out of the “flight-to-quality” trade which has helped mortgage rates over the past couple weeks.

There isn’t much in the way of significant economic data until Thursday this week.  Until then I’ll be tracking the stock market, technical trading patterns, and US Treasury supply.

The US Treasury is set to auction $74 billion in 3-year, 10-year, and 30-year securities.  In addition, they will auction another $136 billion in Treasury bills (securities with durations one year or less).  Click HERE to understand how this can impact mortgage rates.

Given that rates are still very attractive I will maintain a locking recommendation.

Current outlook: locking bias

This morning’s all important jobs report was better than expected (click HERE to learn why this report is so impactful).  The markets were bracing for weak jobs numbers due to poor weather last month but the report indicated that only 36,000 jobs were lost in the month February.  The unemployment rate remains at 9.7%.  A better than expected jobs report is typically bad for mortgage rates.

In other news Greece’s parliament approved the budget plan that was announced yesterday which is designed to help Greece close its budget gap.  The approval puts Greece one step closer to improving their financial health which would likely push yields higher here in the US.

The results of the jobs report often has an impact on the trend in rates for the coming weeks.  Hopefully readers followed our advice yesterday and locked ahead of the jobs report.  If not, I still believe locking in is the best move.

Current outlook: locking bias

The thesis of the article was that due to the Federal Government’s extraordinary efforts to stimulate the economy the nation’s money supply has grown rapidly so we need to be cautious of inflationary pressure; and therefore higher interest rates in the future.

In this morning’s WSJ Kelly Evans sets the record straight by arguing that not only is inflationary pressure an immediate concern for our economy but quite the opposite policy makers should continue to look for ways to boost the money supply to avoid deflation. 

In the article she uses the “M2″ definition of money supply.

The nation’s money stock, known as “M2,” includes physical currency, bank deposits and households’ money-market holdings. The money stock’s growth, which historically averages around 5% a year, has stalled over the past 18 months since the credit crisis intensified in late 2008.

As measured by M2 she has a point.  However, in time it is possible that the Fed’s ballooning balance sheet could work it’s way into the M2 measure of money supply.  Furthermore, as economic activity picks up we will also see the velocity of money (V) increase along with GDP (T).  Therefore, when you look at the equation of exchange that only leads to higher price levels and interest rates.  We’ll have to wait to find out.

Blackrock Inc., the world’s largest money-management firm, announced yesterday that they would be increasing their asset allocation of US Treasuries in their client’s portfolios due to an uncertain economic outlook.  This is a perfect example of a “flight-to-quality” trade where investors purchase relatively “safe” US Treasuries because other investments carry too much risk.  The additional demand helps drive down interest rates.

A day after Greece unveiled their plan to cut its budget deficit they auctioned off €5 billion in 10-year notes.  The auction was met with favorable demand but that has a lot to do with the fact that they are paying an addition 3% of interest above comparable German notes.

None of the economic data released today missed expectations and therefore the markets continue to trade sideways ahead of tomorrow’s jobs report.  The market is already expecting weak jobs numbers (70,000 in jobs losses and unemployment @ 9.9%) so a soft number is not likely to improve rates.  From a technical standpoint mortgage-backed bonds are overbought so I expect rates to move higher before they move any lower.

Current outlook: locking bias

One quick note that is generally applicable to all three sources.  Typically funds derived from a retirement plan used towards the purchase of a home may only be used as a down payment and may not be used to pay closing costs or other debts in order to qualify for a new mortgage.

401K

Rules for each 401K plan are slightly different so homebuyers need to talk with their plan administrators to make sure they can use their 401K.  Technically, a person cannot generally withdraw money from their 401K to use towards the purchase of a home.  Instead most 401K plans will allow participants to borrow money from their 401K and pay it back with payroll deductions.  For funds being used to purchase a home the repayment period can be longer than the normal required period of 5 years but check with the plan administrator to make sue the payments won’t be onerous .

The plan will usually assign an interest rate to the loan but because the participant is paying and receiving the interest on the effective cost of borrowing is 0%.  However, while the loan is outstanding keep in mind that it is  not receiving investment appreciation so the true cost of tapping into a 401K is the “opportunity cost”.  Homebuyers wishing to use their 401Ks should consider the impact this will have on their future ability to retire.

Typically the maximum a person can borrow from their 401K is the lesser of $50,000 or 50% of their vested balance.  If the vested balance is less than $20,000 then sometimes they can borrow up to the vested balance or $10,000 whichever is greater.

It’s important to note that a person does not have to be a first-time homebuyer to use 401K funds.  It’s also important to note that because the homebuyer will pay back the 401K loan with payroll deductions then it is generally not possible to access funds in a 401K with a previous employer.  The homebuyer must currently be working for the plan sponsor.

IRA

IRAs are different from 401Ks in that a person is  able to take distributions instead of having to take out a loan.  The question then becomes whether or not the distribution will be a deemed a “qualified” or “non-qualified” distribution.  A “qualified” distribution IS NOT subject to a 10% penalty while a “non-qualified distribution” is subject to a 10% penalty.

In order for a distribution to be qualified the homebuyer must be a first-time homebuyer which the IRS defines as a person who has not owned real estate in the previous 24 months.  Distributions of up to $10,000 are eligible  to use towards the homebuyer’s down payment only.  The $10,000 cap is a lifetime limit so once a person has utilized the $10,000 they may not use it again.

So long as the contributions to the IRA were tax deductible for the homebuyer then the distribution will be taxed as ordinary income.  If the distribution does not meet the criteria of being a “qualified” distribution then it will also be subject to a 10% penalty.  Since the homebuyer will typically incur income tax liability for an IRA distribution it’s important they account for that when budgeting out their money from the time of distribution to the following April 15th when taxes are due.

Roth IRA

The rules for Roth IRA distributions used towards the purchase of a home are similar to the aforementioned traditional IRA guidelines in that it is only available for those who meet the IRS’s definition of a first-time homebuyer and is only available up to $10,000.  However, there are a couple key differences.

One key difference is that for a distribution to be “qualified” it may not be made inside  a 5-taxable-year period which begins January 1st of the taxable year for which the very first contribution was made to any Roth IRA the homebuyer owns.  In other words, for a first-time homebuyer who wishes to take a “qualified” distribution from their Roth IRA account anytime in 2010 must have made their very first Roth IRA contribution (to any Roth account) no later than the 2005 tax year.

The other key difference is taxation.  Because Roth IRA contributions are not tax deductible at the time of contribution “qualified” distributions are not treated as taxable income.  However, if the distribution is not deemed to be “qualified” then it will be subject to a 10% penalty and depending on the contributions made and distribution taken may also have income tax implications.

I hope this summary enables homebuyers out there to make better decisions with their money.  Please remember that I am not a tax professional and tax code is subject to change.  It is best to discuss your options with a knowledgeable professional when you are close to make such a decision.  It is also important to consider the impact that the decision will have on your ability meet your retirement accumulation goals.

Back on September 14th I covered the gift tax rules for those who make an outright gift to others.  However, I also want to cover loans.

In general loans to family members (or anyone else) are not considered gifts when a reasonable interest rate is charged.  However, there are gift tax implications when “below market” or “interest free” loans are made.  In this instance the IRS will require that the lender recognize the “imputed interest” as a gift to the recipient of the loan.  “Imputed Interest” is the term used in the IRS tax code to describe interest considered to be paid for income tax purposes, even though the interest payment was not actually made.  You can think of it as phantom interest.  The imputed interest is included in the lender’s income even though the lender did not receive any money.  Furthermore, the lender is also considered to have made a gift to the recipient in the amount of the imputed interest.  If the funds are used as acquisition indebtedness to purchase a home then often times the recipient will be able to deduct the imputed interest as mortgage interest even if they didn’t actually pay it.

Imputed interest is based on the loan amount and is calculated by taking the difference between the actual interest collected on the loan and the “Applicable Federal Rate” (AFR) which is the rate the IRS deems as the market rate.  AFR can be accessed at this link and varies depending on the term of the loan.

If a loan was for $10,000 or less then there is no imputed interest and no gift tax implication.

If a loan amount of $10,0001-$100,000 is made then the imputed interest is the lesser of the net investment income of the recipient in that year (if the recipient’s net investment income is less than $1,000 then imputed interest is deemed to be $0) or the difference between the actual interest collected and the AFR.

If the loan amount is in excess of $100,000 then the imputed interest is the difference between the actual interest collected and the AFR.

It is always wise to discuss your gift giving or generous loan plans with a tax adviser or estate planner before writing the checks.  There is significant flexibility in the gift and estate tax code to allow most households to escape tax liability but it may require some careful planning.

Greece unveiled their plan to cut its budget deficit today.  For the first time they included credible details which should help reduce fears about default on their bonds.  Greek officials will meet with EU leaders this weekend to gain support for the plan.  This news is likely to lead to an unwinding of the “flight-to-quality” trade which helped drive mortgage rates below 5.00%.

Domestically the markets are digesting a better than expected payroll report and a better than expected service sector report.  Good news for the economy is often bad news for mortgage rates but traders are hesitant to make any large moves until we get Friday’s jobs report.

From a technical perspective mortgage rates have been unable to break below current levels since the beginning of the year.  The chart below shows a similar trend for the 10-year Treasury yield which has not been able to break below 3.5%.

Current outlook: locking bias