The Fed and Mortgage Rates.

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I’ve lost count of the number of times I’ve been asked “I see the Fed lowered it’s rate(s) today, www.federalreserve.gov/ how much have mortgage rates dropped by”?

When I answer, as is most often the case, “they’ve not gone down, they’ve gone up”, the response is “how can that be.

So let’s try to explain it once and for all.

First the basics.

There are 3 actors in this story.

1.The Federal Reserve Bank.

2. Mortgage Backed Bonds/Securities.

3. Inflation.

FACT: There is no direct relationship between the Federal Reserve and Mortgage Interest Rates.

FACT: Despite the continued repetition from the Talking Heads in the mainstream media, there is also no direct connection between the 10 year Note and Mortgage Interest Rates. In fact the two will often go in opposite directions after a Fed action.

SUPER FACT: Mortgage Interest Rates are directly affected ONLY by the prices of Mortgage Backed Bonds, commonly referred to as Mortgage Backed Securities. For the most part these are Long Term Bonds issued by FANNIE MAE and FREDDYMAC, and it is their price going up or down which drives Mortgage Interest Rates.

As with all Long Term investments, Bonds are most directly affected by the outlook for Inflation, which makes it likely they will be paid back in the future with inflated dollars. Inflation reduces the current value of all Fixed Investments such as Bonds.

The Golden Rules:

1. Prospects of higher Inflation drive down prices of all Bonds.

2. When Bond prices go down, Mortgage Interest Rates go up, and vice versa.

Here is where the Fed comes in. Drastic lowering of rates by the Federal Reserve Bank will always lead to fears of Inflation and put downward pressure on all Bonds. This is precisely what we have seen since the start of this current lowering cycle.

The sole exception to this is your Home Equity Line of Credit (HELOC) which is usually tied to the Prime Rate. The Prime rate is historically 3% more than  the Fed Funds rate; so in today’s topsy-turvy world you will often  find your Equity Line loan having a lower interest rate than your 1st. Mortgage.

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