Another Federal Funds Rate Cut...
What Does This Mean to the Mortgage Market
and to the U.S. Consumer?
Provided by: Genworth Mortgage Insurance
On March 18, the federal (Fed) funds rate was cut again - this time to 2.25 percent. The Fed funds rate has now been lowered a full three points from its hold at 5.25 percent from July 2006 to Sept. 2007. The Prime rate followed the Fed funds rate from 8.25 percent back in Sept 2007 to 5.25 percent following this week's cut.
Why does the Federal Reserve continue to make cuts? Quite simply, it's an effort to increase demand for goods and services, which strengthens the economy.
Impact on U.S. Mortgage Market
The U.S. mortgage market is unlikely to see a significant impact from the Fed rate cuts. Mortgage rates are driven by long-term Treasury yields along with factors affecting investor confidence in mortgages.
This drop will also have a minimal impact on long-term mortgage rates since the 30-year conventional fixed rate mortgage rate is more closely tied to the 10-year Treasury yield. Supply and demand for 10-year Treasury bonds drive price and therefore yield movements. Economic and financial market conditions, among other factors, drive buy (demand) and sell (supply) decisions for long-term Treasury bonds and it takes time for changes in the Fed funds rate to alter those conditions.
What drives rate changes?
Inflationary pressures in today's market (have you been to the gas station or grocery store lately?) tend to drive 10-year Treasury yields higher, which then boost mortgage rates. Recent decline in home prices and the resulting fear of holding mortgage-related assets has further increased mortgage rates as the increase in risk perception shows up in the form of higher mortgage rates.
Second mortgages may be cheaper, but certainly not easier to come by in today's market. A lower prime rate would normally translate to a reduced rate on second-lien ("home equity") loans but heightened risk of this product has driven home equity rates higher for many new borrowers and has dampened the overall availability of these loans. Consumers with an outstanding second-lien mortgage will likely experience a slight drop in their loan rate that would lower their monthly payment.
How does this all affect the consumer?
The average consumer will feel the impact of the Fed rate move in the decline of savings account rates and possibly a drop in the rate on their outstanding credit card balance.
A lower rate on savings accounts simply means that consumers are earning less interest on these accounts.
Consumers with outstanding credit card balances may see a drop in their interest rate and that may lower their minimum monthly payment. Borrowing costs for consumer (non-mortgage) and business investment loans typically come down when the Fed funds rate drops, but tighter lending standards today may limit the growth of these loans.
Presenting consumers with a lower cost option to borrow funds may increase lending and spending activity, which can fuel economic growth and eventually perhaps even create more jobs.
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