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CLIP Index update: August 2014

MoneyRates.com Senior Financial Analyst, CFA
September 17, 2014

It may not last, but overall interest rate conditions have been getting better for consumers for four consecutive months now, according to the MoneyRates.com CLIP Index.

The CLIP Index fell by one basis point to 4.06 percent in August, representing a narrowing of the spread between what it costs to borrow via a mortgage and what you can earn in a typical deposit account.

This is a good news/bad news situation: A narrowing of this spread represents improvement for consumers, but that spread remains much higher than its historical average of 2.86 percent.

Mortgage and CD rates

The CLIP rate has fallen by a total of 23 basis points over the past four months. Since this rate represents the extra interest consumers have to pay for mortgages compared to what they can earn on deposits, the decline in the CLIP rate is good news overall.

Unfortunately for depositors, the decline in the CLIP rate over the past four months has been almost entirely due to a decline in mortgage rates rather than a rise in CD rates. One-month CD rates did increase by a single basis point in June -- their only increase since 2009 -- but they still remain mired near zero, at 0.06 percent.

Meanwhile, 30-year fixed mortgage rates have fallen by 22 basis points over the past four months, to 4.12 percent. In total, they have declined by 34 basis points so far this year. These lower mortgage rates are one of the biggest economic surprises of 2014. The big question is, how long will mortgage rates continue to surprise?

The future of low mortgage rates

If near-zero interest rates on CDs represent the bad side of the low-interest-rate environment, then low mortgage rates certainly represent the positive side of it for consumers. This opportunity is rare -- current mortgage rates are among the lowest in history, and they are increasingly swimming against a tide of economic events. The Federal Reserve is already reducing the intervention that helped make low mortgage rates possible, while continued economic improvement makes higher interest rates an ever more likely possibility.

The real wild card is inflation. Inflation remains low, and has been unusually docile for a long time. In a global economy though, there is no shortage of forces that could cause a sudden inflation shock. Rather than the slow, orderly climb in mortgage rates that would be the ideal scenario as the economy continues to strengthen, an inflation shock could send rates sharply higher at any time.

Against this backdrop, prospective home buyers and people in a position to refinance need to pay attention. For home buyers, the clock is already ticking because of rising home prices; understanding how rare this mortgage rate opportunity is should only add to the urgency. As for refinancing, rising home values are putting some homeowners in position to refinance for the first time. They should jump on the opportunity.

Consumers who are fortunate enough to lock in today's mortgage rates may find themselves doubly fortunate when interest rates return to more normal levels. In a fixed-rate mortgage, they can hold onto low rates for years to come, while a return to more normal CD rates might see those consumers able to earn more on their deposits than they are paying on their mortgages.

About the CLIP Index

The Consumer Lost Interest Percentage (CLIP) Index measures how much interest consumers are currently losing in the gap between mortgage and deposit rates. To create this index, MoneyRates.com compiled 30-year mortgage rates and one-month CD rates going back to 1971. This yields more than 40 years of history to help put the current gap between mortgage and deposit rates in perspective.

It makes sense that mortgage rates exceed the interest rates paid on short-term deposits such as CDs, savings and money market accounts. Mortgages represent longer commitments and thus more risk, plus banks deserve to make a profit on their activities. How much profit is fair is a subjective question, but by measuring the size of the gap between mortgage rates and deposit rates over time, you can tell whether that gap is currently above or below average.

The graph on the below represents the arc of the CLIP Index, measured in annual averages, from 1971 to 2013.

CLIP Index: 1971 through 2013

MoneyRates.com updates the CLIP Index every month to gauge what kind of deal banks are offering their customers. This gives consumers an opportunity to better understand today's banking landscape -- and how to get the most from it.

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