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Jul 27 2011

What Would U.S. Credit Downgrade Mean for Mortgage Rates?

Posted by Suzanne Baker at 1:41 PM

Mortgage insiders in San Diego County and Southern California are closely watching whether the U.S. government's credit rating will be lowered, as debt-ceiling talks continued on Tuesday.

A downgrade of the country's AAA rating, the best possible, could lead to hikes in interest rates and later increases in mortgage rates, which would mean higher costs for potential homebuyers. That, local mortgage experts said, would have significant consequences on an already fragile housing market and consumers who are on the fence about buying a home.

"A downgrade would be very detrimental to the mortgage industry," said Michael Lea, director of San Diego State University's real estate center.

Lea said a lowered credit rating would trigger U.S. Treasury rates, the basis for mortgage rates, to go up. What's more, rates on Fannie Mae and Freddie Mac securities also would increase, "as investors would have less confidence in the ability of the government to backstop the guarantees of timely payment made by the companies on their securities," Lea added.

Richard Green, director and chair of the University of Southern California's real estate center, agreed on the severity of the potential problem.

"(A downgrade) would be a serious problem," Green said. "Default would surely lead to higher interest rates."

Green and others said the expected mortgage rate hikes range from 0.25 percentage points to 3 percentage points.

Mortgage rates are historically low. The average 30-year fixed rate was last calculated by Freddie Mac officials at 4.52 percent and reached a 2011 high of 5.05 percent in February. At the height of San Diego's housing market in 2005, the average 30-year fixed rate was 5.87 percent.

Freddie Mac historical data show spring 2002 was the last time the 30-year fixed rate was in the 7 percent range, where rates could fall if the worst-case scenario were to play out.

Kurt Branstetter, a loan officer with W.J. Bradley Mortgage in San Diego, said the impact of a potential credit downgrade also could have a psychological impact on consumers.

"It would scare them away ... from buying homes at the exact opposite time that we should be doing that," he said.

Speculation on whether mortgage rates could go up immediately or over time is mixed. Branstetter says it may take a couple of years for that to happen as investors would keep "parking money" in mortgage-backed securities, as they're historically safe investments.

Derrick Evens, who hosts a weekday radio show on personal finance in San Diego, said a potential fire sale of bonds at lower prices could ensue if the country's credit rating is reduced.

"If that happens, mortgage rates would go up drastically in a short period of time," said Evens, who goes by Mr. Credit on ESPN 1700AM.

But there's also the possibility the money may not move.

Reach reporter Lily Leung at lily.leung@uniontrib.com or 619-293-1719. Follow her on Twitter @LilyShumLeung and on Facebook.

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