Interest-ing: What Is Going on with Lending?

Bonds, and more particularly the curious subjectivity involved in pricing them, are at the heart of Bloomberg’s business. Many factors affect a bond’s value, including the interest rates it offers, the time to maturity, and the going rate for government issues. Since there is nothing like the New York Stock Exchange or NASDAQ for bonds, there is no way to know exactly what a bond is worth.

John McConville, the editor of Inside Market Data, remembers Michael Bloomberg recounting to him a conversation he once had with a bond trader. Bloomberg asked how the price had been set for a particular bond; the trader replied that he made it up.

Interest rates are at a long-time low. Who is making up these rates? Want a mortgage? Maybe. Want a car loan? Absolutely! Why is it that in a low-interest environment it is easy to get an auto loan, but mortgage loans are still difficult?

There are two basic rules of borrowing. First, you want to borrow money when interest rates are low and pay cash when rates are high. Second, you should match the length of your loan to the useful life of the asset being purchased. For example, you should not take an auto loan for more than five years unless you’re the type of person who holds onto a car forever.


Home Mortgages

After the mortgage interest tax deduction, the current 3.5% mortgage rate is equivalent to 2.9% (for a Maryland resident in the 25% federal tax bracket). Fantastic! So why isn’t everyone getting a mortgage or refinancing?


The reason is that borrowers are running into roadblocks, such as the inability to sell an existing home, owning a home that’s “underwater” (market value is less than the outstanding mortgage), and/or having a high income-to-debt ratio. For other borrowers, their credit scores are causing lenders to reject their mortgage or refinance applications.

Also, banks and lenders are zealously enforcing strict lending rules. Our clients tell us that lenders are asking for immense amounts of documentation (income tax returns, paychecks) and detailed explanations about items on credit scores. In some instances, borrowers have had to produce birth certificates.

Even after jumping through all the hoops, some borrowers can get mortgage loans only by paying well above the lowest advertised rates.

However, it could still make a lot of financial sense to persist in seeking a mortgage or refinancing your existing mortgage. The increase to your cash flow and reduction in interest expense are certainly worth the time and effort. Think of it as a temporary inconvenience for a permanent improvement (kind of like road construction).


Auto Loans

Contrast the mortgage-loan environment with the market for automobile loans. According to the Wall Street Journal, the value of auto loans outstanding at the end of June 2012 was $725 billion-that’s the highest level since 2009.


As we went to press, APL Federal Credit Union was offering a one- to three-year auto loan at 2.39% and a four- to six-year loan at 3.39%. Some lenders are offering loans with terms of 72 and 84 months. Even lending to sub-prime auto purchasers (those with marginal credit scores) is up.

What’s going on? Don’t auto loans get roadblocked, too? (Yuk, yuk.)

Banks want interest income because yields on other investments, like U.S. Treasuries, are very low. Banks are reluctant to lend for purchasing homes due to the length of the loan (15 to 30 years), which increases their risk. By contrast, auto loans are relatively small and have terms of only three to six years. In addition, banks have found that when borrowers get into trouble, they tend to pay their auto loans first, because autos (unlike houses) can be easily seized by banks.

Are we telling you to buy a new car? Not exactly. But we are saying that market conditions are making certain types of borrowing especially cheap, even at a time when all types of loans are at unusually low rates. When making a borrowing decision, it’s a good time to think strategically.