It seems stories on the economy and the Feds are in the news everyday. Because of that, it seems this blog and news sources often talk about the Federal Funds rate. But what does the federal funds rate do, and how does it impact mortgage rates? To answer those questions…
The federal funds rate has a direct impact on the rate at which banks borrow and lend money. The Fed rate determines prime rate, which follows along with the federal funds rate. For instance yesterday, the Fed rate dropped from 4.25% to 3.5%, and prime rate followed by dropping from 7.25% to 6.5%. Banks use prime rate to determine rates for 2nd mortgages, home equity lines of credit, credit cards and car loans.
While this is helpful for 2nd mortgages, 1st mortgages generally suffer. I know what you are thinking — but why? There are some reasons, and I will list them below. First remember mortgage rates are determined by the mortgage-backed securities bond market. When more money is invested into bonds, bond prices go up, and mortgage rates go down. However, when more money is put into stocks, less money goes into bonds… bond prices go down… mortgage rates go up… etc.
With that in mind, here are the ways in which cuts to the federal funds rate tend to hurt 1st mortgage rates:
- Federal funds rate cuts increase investing: If banks (and people) can borrow money at a cheaper rate, they are likely to increase their investments in the stock market. This means that more money is being put into stocks, and less money goes into bonds (not to mention money being taken out of bonds to invest in stocks). This action causes bond prices to go down and mortgage rates go up.
- Federal funds rate cuts cause inflation. Again, if banks (and people) can borrow money at a cheaper rate, this leads to an increase in spending. With an increase in spending, the demand for products and services increases, which drives up the prices of those products are services – otherwise known as supply and demand. The increase in price is inflation, and bonds hate inflation because it hurts the value of the U.S. Dollar. If it costs more money to buy the same goods or services today than it did yesterday, it means the Dollar has lost some of its value. Again, bond prices go down and mortgage rates up.
- Federal funds rate cuts decreases the value of the U.S. Dollar: Inflation hurts the value of the Dollar, which also makes foreign goods more expensive to buy. This may be all well and good for individuals concerned about our trade deficit, but it still costs more money for companies to buy the same products that they turn around and sell to us in stores. The price increase is passed on to us, the consumer.
Right now the bond market is doing rather well. This is due primarily to the slowing down of our economy, which has led to the Feds making several cuts to the federal funds rate. At some point, these cuts will catch up to the bond market and rates will go up. This is why I advised anyone looking to refinance or purchase a home to consider locking in sooner rather than later. Take advantage of the gains in the market that have put us near all-time record lows for fixed rate mortgages before the market turns around.
Clay Jeffreys is a Mortgage Consultant with Hillside Lending, LLC and writer for “Blog Pertaining to the Acquisition of a Mortgage to Purchase a Domicile.” Hillside Lending seeks to provide mortgage brokerage services with the highest standards of service, care, honesty, integrity and value; concentrating on owner-occupied, residential financing. For more information about available programs and interest rates, please visit www.hillsidelending.com.
