Say good bye to mortgage interest rates in the 5’s, at least for a while, as they made a decisive move higher last week. Why are we waving a fond farewell? It’s not as much the rise of about .25% in mortgage rates as it was the establishment of a clear downward trend in mortgage bond prices, which translates to higher mortgage rates.

What next? Don’t look now, but the economy is beginning to look downright rosy! Recent reports show a clear turning of the tide, from the economic doldrums of the past few years to the makings of a sustainable, healthy and vibrant economy. From employment numbers to the once troubled manufacturing sector to the now robust corporate earnings…things are clearly looking up. Stocks have been on a roll, housing remains a pillar of strength and consumers are feeling better about the future. During the first three months after the enactment of the tax cuts, the results show that those dollars are now being spent and put back to work into the economy. The holiday season is just around the corner, and if early signs on retail sales are strong, stocks may really move higher based on these continuing positive indications from the consumer.

So what does all this optimism mean for housing and mortgage interest rates? Like many things, it’s a “good news - bad news” deal. The bad news first. The strengthening economy will pressure mortgage interest rates higher. How much higher? Expect increases of around .25% into the end of the year, followed by another .50% to .75% during 2004. Ready for some good news? Home buying is far less tied to mortgage rate than many think. Individuals rely more on feelings about their own job security and the economy in general than a modest rate increase. So housing should remain very strong throughout most of the country for the next few quarters.

But what if a gift is needed for the down payment of a home purchase? Should the donor or recipient be spooked about heavy tax consequences? Treat yourself to the Mortgage Market View below, and learn the surprising truth…

Take a look at the chart below. There is now a clear downtrend in mortgage bond prices, translating into higher mortgage interest rates over the past several weeks. What’s in store for the week ahead? Several scenarios could play out.

On Friday, stocks dipped and offered a slight reprieve, causing bond prices and mortgage rates to improve slightly. This may have been a “head fake” due to Options Expiration Day. Didn’t celebrate it? Never heard of it? Simply means that stock options expire on the 3rd Friday of the month, which can push the markets in unusual ways. Historically, when Options Expiration Day causes a decisive market move, it corrects on the following Monday. Since stocks moved decisively lower Friday and Bonds moved higher, we expect the opposite correction to take place on Monday. This would cause mortgage interest rates to worsen slightly.

More history: stocks typically go in the dumper in September and October...and so far this hasn't happened. The 16-Year Anniversary of Black Monday was on October 19th. Stocks are trading near strong resistance, and in an overbought state, they may be ripe for a correction lower. While another Black Monday is not in store, it wouldn't be a shock to see stocks move a little lower, causing mortgage interest rates to gain a small improvement.

This week also brings another robust stream of quarterly earnings releases to the stock market. This stream of earnings news may create extra volatility in the markets and could drive the stock market in stronger moves in either direction depending on the nature of the news. If the earnings reports continue to be favorable, stocks could move higher to the detriment of bond prices and interest rates. If the earnings news is more negative, then stocks could sell-off and provide more funds for bond investing, resulting in slightly lower interest rates. Most likely, mortgage bonds will move in a sideways to lower fashion, resulting in stable to slightly higher mortgage interest rates for the week.

The “GIFT TAX” – Fact or Fiction?

An old French proverb says, “No one is so generous as he who has nothing to give”. But luckily, many homebuyers are offered a gift of cash from generous family members to assist them in the often costly venture of purchasing a home. But many of these homebuyers and their donors fear being immediately hit with a mysterious tax if the gift is too large. Here’s the surprising truth.

Regardless of the size of the gift, there is absolutely NO gift tax that hits immediately. In fact, the only tax implication is a deduction of the estate tax credit, which may never even come into play. If it is of any impact, it is only an issue when the donor dies and the estate is evaluated for tax purposes.

The straight scoop. First, under present IRS guidelines, an individual can legally give up to $11,000 to another individual each year without any tax implications. The amount can be even higher depending on whether one or both parents give the maximum amount to their child and their child’s spouse. For example, one couple could give their son a total of $22,000 and their daughter-in-law another $22,000, but the couple won't have to ever pay any taxes related to the gift because they wrote separate $11,000 checks to each of the recipients.

Here’s the part most people, including industry professionals, misunderstand.

For gifts that exceed $11,000 per year to an individual, the tax impact ONLY comes into play at the time of the donor’s estate settlement. When the estate is evaluated for tax purposes, there is a certain amount of assets that are exempt from tax altogether. For 2004 there is an exemption of $1.5 million of assets from the federal estate and gift tax. It's a "unified" exemption from the tax - meaning it applies to the accumulated total of gifts and to the total of an estate. Technically it's a tax credit eliminating the estate or gift tax on the first $1.5 million of an estate. For example, if an estate were settled in 2004 and contained assets of $2 million; if gifts previously given never exceeded the per year, per individual limits, only the assets exceeding the $1.5 million would be subject to taxation, just as they would be normally if no gift had been given. Estate tax would be due on $500,000.

Another example. The same $2 million estate value, but last year, a gift of $111,000 was given from that individual to a daughter for home purchase. Because this exceeds the $11,000 per person, per year limitation, the excess of $100,000 is now dealt with on the estate. Instead of receiving a $1.5 million tax exemption, the $100,000 is deducted, and only a $1.4 million exemption now applies. Estate tax would be due on $600,000.

Viewed one more way. If you made gifts of $2 million during your lifetime which exceeded the normal limitations, the first $1.5 million would be free of any gift tax and the next $500,000 would be subject to the gift tax. Your estate would not be able to use any exemption because it was all used up in order to avoid taxes on gifts.

Due to the complexities of the gift, estate, and unified credit tax rules, it is always a good idea to consult with a tax advisor to determine the best way to make a gift based on specific financial situations.

The bottom line: Generous donors and lucky recipients have much, much less to fear than they think.

There are only two economic news releases scheduled for the upcoming week. Of these, the only report having potential to cause any bond market reaction will be the Initial Jobless Claims report on Thursday morning, with no surprises anticipated. This means that mortgage bonds and mortgage interest rates will take primary direction from stocks. If stocks improve, bonds will suffer and mortgage interest rates will worsen. If stocks do poorly this week, bonds will be the beneficiary and mortgage interest rates will improve.

For the week of October 20th - October 24th, 2003