30
2008
Federal Reserve Rate and Mortgages
The Federal Reserve recently cut the Federal Funds Rate by another 50 basis points, racking up a total cut of 125 basis points in eight days. While this latest cut did not surprise the market, borrowers should expect this rate cut to have an effect on current mortgage rates and potentially the overall housing market.
Federal Reserve RateMost non-investors have very little understanding of what the Federal Funds Rate is. The Federal Funds Rate is the interest rate on overnight loans between banks. These loans are required because the Federal Reserve mandates that banks keep a certain amount of cash in reserve. These accounts settle nightly. Rarely does any bank have the exact funding requirement. When banks have more cash than required, they lend that cash out to other banks at the Federal Funds Rate, who may not have enough to meet the requirement. While this is a very simplistic way of describe a complicated system, the lower this rate becomes, the cheaper it is for banks to lend money.
Consider this simple example. If the Federal Funds Rate is 4%, then banks must charge greater than 4% to lend out their money. If they charge less, then they would be losing money every night that they fall below the reserve requirement. Additionally, as the rate increases banks will be more hesitant to fall lend more to avoid going below the require. This leaves less money available to loan, increasing interest rates. The higher the Federal Funds Rate, the more expensive it is for banks to have to borrow nightly, ultimately resulting in higher interest rates. While this is certainly an over simplification, it should give a basic understanding about how lowering the Federal Funds Rates will effect mortgage lending.
Mortgage RatesThe correlation between the Federal Funds Rate and Mortgage Rates can be seen in past recession. Back in 2001, the Federal Reserve aggressively slashed rates to stave off a recession, subsequently leading to the housing boom and historically low mortgage rates. This same story is playing out now as the Federal Reserves acts once again to stave off a recession. Mortgage rates dropped significantly over the past two weeks and should drop yet again in the next week or so.
Borrowers considering buy a home should look to lock in a fixed rate as soon as the new mortgage rates come out. While there is no telling what the Federal Reserve will do in the future, 3% is a very low for the Federal Funds Rate historically. Additionally, for those looking to refinance their homes, their may not be a better time then right now.
by Michael Cook
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