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Fed Holds Rates Steady & Impact on Mortgage Rates

Mortgage and Lending with Cumulus/Ann Arbor Radio

The Federal Open Market Committee (FOMC -aka The Fed & Ben Bernanke -Fed Reserve Chairman) held the Fed Funds rate steady today at 5.25% (http://money.cnn.com/2007/05/09/news/economy/fed_statement/index.htm?postversion=2007050914 -Fed's Statement)

For clarification purposes I will explain first what the Fed Funds rate is and then what this all means for mortgage rates.

The Fed Funds rate is the rate at which the Federal Reserve Bank will lend money to banks on a short term basis.  This rate is determined monthly by the Federal Open Market Committee. 

What this means to most people is it is the basis for which our short term interest rates (Home Equity Lines of Credit, Credit Cards, Commercial Loans) are based.  The prime rate we see so often is typically 3% above the Fed Funds Rates, therefore todays Prime Rate is 8.25%.  The majority of Home Equity Lines of Credit (HELOC) are based on Prime + 0-6%.  If you have a home equity line of credit, your interest rate stayed the same today.

What does this mean for Mortgage Rates?  Not much, really.  First Mortgages are traded on a completely separate market - called the Mortgage Backed Securities Market.  This is where mortgages are bundled and sold like bonds. 

Naturally, the Fed's statements about the market, long term inflation, and the impact it has on stocks will all indirectly impact mortgage rates, however that is usually the extent of it. 

Where do I think rates are headed and why?  

First off, if I really knew the answer to this I'd probably be trading on the Mortgage Backed Securities Market.  Second, nothing is a guarantee in an open market.  Third, these are my opinions and I am not an attorney, CPA or any sort of financial analyst. 

Long term mortgage rates appear to be very steady right now.  All of the panic we heard about with Sub-Prime has yet to really impact our A paper and 30 year fixed rates.  Mortgage rates, historically speaking, are at very attractive levels. 

The big buzz word on CNN, CNBC and business news channels is Liquidity (people or institutions with a lot of cash).  This has led to a number of very large acquisitions (Mergers) and public companies going private or getting bought out by private equity.  All of this liquidity is typically a good thing for mortgages.  Investors need somewhere to put that cash for a better than savings account return, such as the Mortgage Backed Securities Market. 

If there is a slow down in the economy and the stock market starts to slow down, investors will also be looking for places to put their cash which should help support these levels.

Some of the risks: inflation, foreign investment, foreclosure rate. 

The inflation risk is pretty easy to explain.  If prices inflate, investors will demand a higher rate of return for their cash investments (banks for example will pay higher interest rates on savings accounts, therefore this will increase our mortgage rates to attract the investment.) 

Foreign investment is much more complicated, for example let's take China.  China buys billions (lots and lots of them) of Mortgage Backed Securities.  They do this to help support their currency as compared to the dollar (this is complicated and over simplified here but the gist is correct.)  This keeps our rates low because China comes in and supplies this market with much needed cash.  If China were to stop doing this there would be less supply therefore rates would have to increase to attract more investment.  (For the record, China's support of their currency vs. the dollar is not the best situation for our economy as a whole and an entirely different topic.)

The foreclosure rate (Number of homes that go into foreclosure per 100) is a measure of risk for this type of security.  In other words, if only 0-1% of the homes go into foreclosure it is not very risky.  This type of mortgage (A paper) pays less to an investor (because it's not as risky) than a group of loans with a higher foreclosure rate.  This is essentially what has happened to the sub-prime market.  Too many loans went belly up and the risk was too much for the investors to handle.  As long as the A paper loans don't increase their foreclosure rate then we should be okay.

So what did I say about mortgage rates?  The Fed Funds rate only indirectly impacts mortgage rates.  Right now, mortgage rates continue to remain at attractive levels and don't look to be going up anytime soon.  I do not expect rates to move much more than 0-0.5% in the next six months.

If I haven't bored you to death yet, I thank you for reading my summary of the Fed's Rate Decision.  Please feel free to correct me, add to this or just say hello.

Tony D. Howell
The best place EVER! - Wilmington, NC
Looks like you "get it".  Most guys in our line of work DON'T!  Good post!
May 09, 2007 08:01 AM