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Fed Cut expected to “rates”, but just what does that mean for mortgage rates?

Posted on September 17, 2007 by Ray Williams (NMLS #216267).

Hello all,

At this point it is a foregone conclusion that the Fed is expected to get in the mix tomorrow at their much anticipated meeting by lowering the Fed Funds Rate by either .25 or .50 from its current levels. Whispers on wall street backed by the early signs of traders would expect to see something along the lines of .25 of a cut from its current levels, versus the .5% cut that many politicians would like to see.

What exactly this means to all of us consumers can be confusing. First, if you understand the Fed Funds rate you know it is what is tied into Prime Rate (which is the rate banks charge their best customers for short-term lending). This means if you currently have a Home Equity Line of Credit at say Prime + .5% then you will see on your next billing cycle that your rate should be 8.5% (Prime dropping to 8% and adding that to your margin of .5%) from there many people will ask me, “Ray, I am going to wait to refinance because Bernanke is lowering rates”. The confusion comes from hearing that they are lowering rates and thinking it means mortgage rates. What they are in fact lowering is the Fed Funds Rate. Historically this has had an inverse (opposite) impact on long-term mortgage rates over time. Which means we could expect to see mortgage rates rise off the heels of this news.

More recently, the driving force of the mortgage backed securities (mortgage rates) has been the Fed’s viewpoint on where Inflation is in regards to all of this news. If you saw Greenspan’s interview on 60 minutes on Sunday night you would have heard him talk about inflation as the thing to be concerned about over time for our economy , not the current housing market/ mortgage issues.

The easy way to understand this is to think about what a bond is. A bond is simply a note payable. So if you were the owner of a bond at a specific rate you would receive a certain return on your investment. So, knowing that mortgages are in fact BONDS you can understand that if in fact there was a concern of inflation, there may be a concern that in the future your bond wouldn’t be worth as much money if inflation caused the future value of your money to be less. So you can see why then if there is a cause of inflation then the value of bonds deteriorates, thus the result is when there is inflationary concerns from the Fed that mortgage rates suffer and go up.

Keep your fingers crossed tomorrow. I think it is needed to see rates decrease on short-term money, but I am cautiously advising my clients right now to lock their rates if they are closing in the next 2 weeks. After all, you have more to lose if your rate goes up on the news tomorrow. If you are comfortable with your current rate and payment my advice is to lock your rate and take the safe bet on your next mortgage.

If you have questions on the meeting tomorrow or about the loan you are trying to get shoot me an email at rwilliams@summit-mortgage.com so we can talk about your mortgage.

~ Ray

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