Drop in Federal Funds Rate = Drop in Mortgage Rates?

Drop in Federal Funds Rate = Drop in Mortgage Rates?
by Hassan Nicholás


By now, we are all pretty accustomed to the bleek news that's reported daily about the failing real estate market. You might have even become desensitized to it and found other crises to worry about. So when we hear that the Fed announced another rate reduction, how should we respond? The little bit of optimism that we have left might tell us that we can expect a drop in mortgage rates, right? The short answer and probably most accurate is, we don't really know.

It's probably not the answer you wished for or what you've been reading from all those popular real estate discussion boards you're a member of. But my teachings in economics is begging me to resign to that fact that we can't predict the unpredictable...beyond predicting it's unpredictability (that's one for the books!).

So what does happen when the Fed reduces its rate?

For the sake of not boring you, I will keep this related to you and your interest in purchasing a home. When the Fed reduces the rate it is an attempt to stimulate the economy and encourage business. The Fund Rate is basically the rate of interest banks are charged for short-term loans.
Changes in the Fund Rate affect you because things such as credit cards, auto loans, ARMs and HELOCs (home equity lines of credit) are based off the Prime rate, which is derived from that rate of interest. So, when the Fed lowers the rate loans pinged to the Prime rate become cheaper. You will be more likely to break out the plastic in the department store, take out a car loan, or borrow money to expand your business - basically, you will be encouraged to spend and heat up the frozen credit market. Conversely, Certificates of Deposits and your online bank account at ING Direct will yield less.

Where does mortgage rates come in, you say? Since mortgage rates are long-term loans, they are less affected by changes in short-term rates. Mortgages are sold to investors as asset-backed debt called MBS (Mortgage Backed Securities). Basically, a piece of your mortgage is bought by a pool of investors, who then technically "own" your loan. The mortgage servicer, who you write your checks to, is the entity that "holds" the loan. The value of MBS are fixed, so when the future future value of MBS goes down the rate of interest to the homeowner will go up. However, this is not guaranteed. We have infact seen interest rates fall when the Fed made adjustments. [See where they're at now.] Historically, current mortgage rates are at a low, so instead of waiting for the housing market to bottom out or predict where mortgage rates are going, it might give you peace of mind (and save you money) to buy now...that is, of course, if you can afford it. But, we'll discuss whether or not now is the time to buy in another thread...

Higher Rates, Good or Bad?

by Hassan Nicholás

High Rates, Good or Bad?

When one gets wind that interest rates are rising this could produce a myriad of emotions, some more pleasant than others. For the credit-strapped borrowers looking to take advantage of falling home prices a hike in interest rates could be a deterrent, or rather, the determining factor that could break the camel's back. Hopefully, by now we all know (or should know) that our mortgage payment is PITI..Principal, Interest, Taxes, & Insurance. Accordingly, interest rates affect the size of our monthly mortgage. So, should we be alarmed then when the Fed has risen rates? Would it then be safe to say that any savings we would have realized from a discounted purchase price would be negated? To be fair, let's make sure we understand that when the Fed talks about lowering the "rate" it is referring to the Federal funds rate, which is not the same as the mortgage rate. Now, let's look at how a rise in interest rates will affect certain groups of people.

Investors - High interest rates means you can invest your money at a higher rate of return, right? OK, but the interest rate you get paid on investments is tied to the Federal funds rate, which will be lowered March 18th. So, even if rates for 30 year mortgages are rising, currently, you will still be earning less on your investments.

ARMs/IO/Open Option ARMs - If you happen to have an ARM, Interest Only or Open Option ARM that's due to reset in a few years you could very well count on a jump (sometimes very substantial) in how much you'll shell out a month for your mortgage. You've been warned.

Buyers - It's best to buy when rates are higher and prices are lower. You'll have more interest to write off for tax time (plus, additional tax credit using a Mortgage Credit Certificate, if you qualify), greater chance to refinance later for a lower rate, and then the added incentive for sellers to lower purchases prices.

It really all depends on which side of the fence you want to be on.

Many mortgage experts believe rates will be at a standstill at least for the short-term (next 45 days). However, there are those that believe rates will drop and another minority that believes interest rates will rise. Catch the discussion on BankRate.com to see what the experts and analysts are saying.