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The Fed Funds Rate Does Not Directly Impact Mortgage Rates

It's been on the news a few times lately, so let's address a key misconception about the Fed and its relationship to mortgage rates.

The markets now anticipate that the Fed will lower the Fed Funds Rate within the next 45 days. As a mortgage rate shopper, there's not much reason to be interested. That's because the Fed Funds Rate is not directly tied to mortgage rates.

The chart above is courtesy of HSH Associates and shows how the Fed Funds Rate has moved in relation to mortgage rates since June of 2004. If there was a connection between the two, mortgage rates would have moved higher along with the FFR (brown) line.

The FFR is important because its used as a throttle for the economy. The higher the rate, the harder is it to borrow money and/or finance "stuff", and so, therefore, the lower the throttle. When the FFR is lowered, it signals that the economy is slowing down too fast for the Fed and a little bit more "gas" is needed.

Economists are fearful right now that credit market turmoil will rapidly decelerate the U.S. economy and that is why they are calling for the Fed to lower the Fed Funds Rate. A lower FFR could add some life to business and consumer spending and that is what propels our economy forward, of course.

Whether the Fed does, or whether the Fed doesn't, expect mortgage rates to remain relatively stable regardless. Interest rates on mortgages are set by the demand for mortgage-backed securities, not by the Fed Funds Rate.

Posted by Ilyce N. Powell, CMPS™ - Certified Mortgage Planning Specialist on 08/14/2007 10:28 AM

Comments (9)

business, consumer education, education, finance, interest rates, mortgage, federal funds rate, economy, mortgage market

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9 Comments on The Fed Funds Rate Does Not Directly Impact Mortgage Rates

AUG

2007

Ilyce, I like how you think. Always educate the public and our clients to the reality of our business. How many times have we answered the customer's question about "I heard that the rates went up or down yesterday"? Thanks for contributing to the community and keep up the good work.

After this sub-prime fiasco that currently occurring, borrowers have to be squeaky clean and everything is going to be verified.

So won't those nice low rates only go to the best qualified. And the rest will as always pay more?

Jim - Thanks for the support. I really appreciate it.

Armando - That's not necessarily the case. FHA is coming back "in style" now. And although FHA loans may require a little more "verification," the credit scores and rates can be lower than what you'd expect for a conventional loan - and don't forget: the borrower only needs to contribute only 3% from "flexible" sources, including gift funds.

AUG

2007

Interesting........ I never thought of that before......

Sounds like a bookmarked post for sure!!

=-)

AUG

2007

Thanks, Alex. Hopefully, being able to explain this will further heighten your status with your clients.

This is a great post. I'm not convinced that lowering interest rates in this market makes sense. Rates are still fine, the issues are much bigger than a simple interest rate reduction. What's happening now goes to the core of the investors bellie - fear!

Lowering of interert rates is supposed to help money move through the economy faster! The feds are pumpping money into the system and buying the subprime bonds that noone else will buy and it's still not helping.

In normal times, this is a great client educational tool - these are not normal times!

AUG

2007

Hi Kate. Thanks for your comments. Just to be clear, my post was to take the focus off of the Feds and make sure folks aren't following the wrong indicators.

APR

2008

Great presentation on this subject.

I use these statisticcs with both buyers and sellers.

Se my post at: http://activerain.com/blogs/jpeters

The true barometer of mortgage interest rates is Mortgage Backed Securities (MBSs). The 10 Year Treasury Bond yield preovides a general indication of where mortgage rates are going. (Note: the operative wordhere is "general." Sometime mortgage rates go UP when the discount rate goes DOWN.)" And the Fed Discount Rate has nothing to do with either. That's the overnight rate the feds charge banks for borrowing money.

And yet - and I get it all the time (as I'm sure you do too) that when the feds cut the discount rate, everybody calls up and says "The feds just cut the rates again. How come the mortgae rate didn't go down?" Or, "I'm gonna wait for the rate to go down - the feds just cut the interest rates again." Oy vey!

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