Fed's Impact On Mortgage Rates

The Fed lowered rates! How does this impact my mortgage?

You grab the newspaper today and you see that the Fed lowered interest rates again. Your normal and natural translation is that mortgage rates have subsequently been reduced as well. Well, you couldn't be more wrong. In fact, often times the complete opposite occurs.

First of all, the Federal Reserve has absolutely no direct impact on mortgage interest rates. The Federal Reserve controls the Short Term Overnight Lending Rate, the Fed Funds Rate and the Discount Rate, which have a very close relationship to the Prime Rate.

Let's take a quick trip back in time. On November 6, 2001, the Federal Reserve decreased interest rates by 50 basis points. This was the tenth time in the calendar year that it had lowered rates. However, between November 7, 2001 and the end of the year, mortgage rates increased by as much as one full percent.

A lot of people chose not to lock in their mortgage rate because they thought rates were coming down. All they saw was the media reporting that the Fed was lowering rates again. As a matter of fact, the Fed lowered rates again in December for the 11th time that year. But by late 2001, mortgage interest rates were higher than they had been at any time in 2001. That's right, higher than they were before the Fed started their first decrease in January 2001, higher than it was after 11 decreases.

The reason for this is a matter of cash movement. The stock market has as much of an impact, if not a greater impact, on mortgage interest rates as the Federal Reserve. Mortgage interest rates move in accordance with the trading of what is called the mortgage backed securities. This is a secured instrument similar to that of a bond, and when people are putting money into equities (that being the stock market), the money going into stocks is typically coming out of bonds and mortgage backed securities to fund the purchase of these stocks.

When the stock market is selling off, money is coming out of stocks and the money needs to have a place to be parked, in many cases a safe haven, to generate a secured guaranteed yield. That is when the money goes into bonds or mortgage backed securities. When the money goes into bonds or mortgage backed securities, rates on mortgages come down. When mortgage backed securities are sold to generate cash flow to invest in stocks, rates go up. So, the much more accurate and dynamic relationship is that between stocks and mortgage backed securities, not the Federal Reserve.

So, donít be confused just because the Fed is meeting next week. Just because the Fed is expected to lower interest rates, this does not have a direct impact of any positive result for your home mortgage.



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