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Mortgage rates are not correlated with Fed Funds

September 22nd, 2007 3:41 PM by Sam Kader

Whenever the Fed cuts the federal funds rate, my phone ring continously from customers wanting to take advantage of a drop in mortgage rates. Things are not that simple. Mortgage rates go up and down according to investors expectations of long-term inflation. Simply put, if investors think inflation will accelerate, mortgage rates rise.

The Fed Funds rate is the rate at which banks lend money to each other overnight and is not directly tied to consumer products like purchase or refinance home loans.   While the Fed Funds Rate doesn't directly dictate mortgage rates, the two tend to correlate over time.  At its most basic level, the Fed rate dictates the cost of short term money, which has ripple effects that carry through to longer term financing costs, like those associated with things like 10yr Treasury notes and mortgage rates. With so many financial institutions borrowing short term money for all manner of spending, even a .125% increase in the cost of that money would be grounds for significant adjustment in financial markets.  

Mortgage rates often anticipate Fed rate moves instead of reacting to them. Two months ago, in mid-July the average rate on a 30-year, fixed rate mortgage in's weekly survey was 6.82 percent. This week, it was 6.32 percent. Exactly half a percentage point lower. The Fed just reduced the federal funds rate by the same margin of a half a percentage point. When the mortgage rates decline, they are reacting to market forces and the fed eventually plays catch-up.

Falling house values pose a severe problem for homeowners who made small down payments a few years ago and for adjustable-rate mortgages. Hundred of thousands of people find themselves in a situation where their ARM rates are rising, yet they can't refinance their mortgages because they owe more than their houses are worth. Thankfully this phenomena has not hit our areas yet.

Falling prices create winners too especially when mortgage rates are relatively low as they are now. As a broad group anyone who is a renter and might look to buy at some point might take advantage of current market situations.   

Posted by Sam Kader on September 22nd, 2007 3:41 PM



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