Real Estate Insights

You may expect that mortgage rates would follow in the direction of another Fed rate cut but this will most likely not be true. Interest rates on long-term mortgages are affected by many different forces in the economy. Lately, they have been affected most of all by increased concerns for inflation and lack of investor confidence.

Below is an article an article that I read in the Mercury News this morning that does a fairly good job at answering the questions about the affects of Fed rate cuts on long-term interest rates such as those offered on home mortgages. You may also be surprised to find out that after every single rate cut since the Fed’s began cutting rates back in October of 2007 we’ve seen mortgage rates rise, not fall.

Think about the Fed Funds rate as a short term rate – on which banks can borrower money for up to 28 days. Mortgage rates are long-term rates and are therefore subject to increased inflation risk - when it is assumed rates will rise in the future the investors (banks and Wall Street) lending on 30 year mortgages want to make sure that their investments are secured against increases in inflation that can erode the value of their investments. The risk for inflation will increase when short term rates are decreased, so most of the time when the Fed cuts rates, mortgage rates will move in the opposite direction.

Filling some holes on interest rates

By Sue McAllister, Mercury News 3/18/2008

The economy could get a needed boost if more prospective home buyers would go ahead and buy homes. But can the Fed really help that process along? Here are answers to some of the questions consumers understandably have about today's mortgage market, which Keith Gumbinger of HSH Associates, a New Jersey-based publisher of financial information, calls "a swirling mess."

Q: If the Federal Reserve reduces the target interest rate at which banks borrow money from each other, as it is expected to today, will rates for fixed-rate mortgages fall too?

A: Probably not. Rates might even rise. The Fed has no direct control over mortgage rates; rates for 30- and 15-year fixed-rate mortgages are essentially set by those investors who are willing to purchase bundles of these mortgages - "mortgage-backed securities" - from Wall Street. Rates have risen lately to compensate for the threat of inflation, which erodes the value of investors' returns. Also, investors are hesitant to buy some types of mortgage-backed securities because so many borrowers have defaulted in recent years, leaving them with nearly worthless investments. With low demand for these products on Wall Street, lenders want to keep mortgage rates - and therefore the yields on securities - high enough to attract investors.

So, Fed rate cuts have made it cheaper for lenders to borrow money, but so far, lenders are not passing much of that savings along to fixed-rate loan customers. They're using it to boost their profitability.

Q: What about rates for adjustable-rate mortgages (ARMs)?

A: Homeowners with ARMs may benefit from a Fed rate cut, as rates on most ARMs are tied to other short-term interest-rate indexes, such as the average of one-year U.S. Treasury bills. Those tend to move in line with the Fed rate changes.

Q: Have any mortgage lenders come out with rates for the new "jumbo-conforming" loans - the ones of up to $729,750 that financing companies Fannie Mae and Freddie Mac can now buy from lenders and sell to investors?

A: A few, including Wells Fargo, Chase, IndyMac, Washington Mutual and Countrywide.

Q: What are the interest rates?

A: They vary. But, for example, the best rate for a new 30-year, fixed-rate "jumbo-conforming" loan was 6.25 percent Monday, said Will Clinton, a mortgage broker at AccessPlus Mortgage in San Jose. But 30-year fixed "conforming" loans of $417,000 or less were available at about 5.5 percent.

Q: Why so much higher for "jumbo-conforming" than for "conforming"?

A: Because of the perceived higher risk of these larger loans, rates are higher.

Q: Should I expect more changes to come in mortgage rates, programs and lending criteria?

A: Yes.