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Stocks struggle as fiscal cliff uncertainty hits the markets

Banks and bond markets were closed Monday in observation of Veteran’s Day. Stock markets opened with a brief morning surge, but the three major U.S. stock indexes (Dow, S&P 500 and Nasdaq) moved slightly below opening levels as the day progressed.

Last week, stocks had their worst week since June, as markets turned their focus from the election to the upcoming “fiscal cliff” dilemma that you will begin to see headlines about every day.

Mortgage rates dropped along with stocks, as investors moved from volatile stocks into the relative safety of U.S. government debt. When Treasury prices increase (dropping yields), mortgage rates drop.

With banks closed today, rates will remain at Friday’s low levels. We can expect mortgage rates to remain low during the Fiscal Cliff discussions. Volatility and danger in stocks usually ends up by pushing investors into U.S. Treasuries, thus (ultimately) putting downward pressure on mortgage rates.

We will take a much closer look at the fiscal cliff, including its effect on mortgage rates, in the coming weeks. For now, the basics:

The fiscal cliff is a combination of automatic government spending cuts and tax cuts and deductions due to expire at the end of the year. Congress has until December 31 to put together a “debt deal” that will go towards reducing the deficit in order to avoid the automatic spending cuts.

Should no action be taken, the combination of tax increases and spending reduction could cause the U.S. to sink quickly into another recession. We saw one estimate that the “cliff” could take $607 billion from the economy (from tax increases and spending cuts). According to one estimate, it would take unemployment back up to 9.0 percent.

The real estate market is watching this problem closely as well. The Mortgage Forgiveness Debt Relief Act was passed in 2007 to relieve the tax burden on struggling homeowners that participate in a short sale or mortgage debt reduction program. Without the tax deduction, homeowners would be taxed for “forgiven” debt. In a short sale, for example, the bank allows the homeowner to sell the property for less than the mortgage is worth. For example, the homeowner might sell for $280,000 when the property is worth $320,000. The original law counted that $40,000 discount as taxable income. The Mortgage Forgiveness Debt Relief Act took that tax burden off the books.

We profiled the San Luis Obispo Real Estate market on Friday and concluded that the market has shown some real signs of recovery. If the Debt Relief act were to expire, the market would be negatively effected, possibly sending home prices back down to the bottom as foreclosure activity ramps up again.

Let’s hope that Congress shows support for the housing market and passes an extension for the Mortgage Forgiveness Debt Relief Act.

Written by Central Coast Lending - Go to Central Coast Lending's Website/Profile