Guest Columnist: George Lourigan

February 8, 2008 at 9:02 pm , by Jenel Looney

Today, George Lourigan, a Mortgage Consultant with Extraco Mortgage, has been kind enough to write an article for this website, to help homebuyers understand the Fed rate.

What does “The Fed Just Lowered the Rate” Mean to Me?

What does it mean when we hear that the Fed just lowered the rate again? We have all heard that the Fed either has lowered the rate or is going to lower the rate. But what does that really mean to each of us? Does it mean that it is time to refinance? Does it mean that interest rates on home mortgages are going down? Does it mean that it is a good time to buy a house?

To answer these questions we first need to know what interest rate the Fed controls. The Fed meets once a month to look at the economy and determine if they need to do something to keep the economy growing at the desired rate of 3%. The Fed influences the economy by controlling the Discount Rate and the Federal Funds Rate. The Discount Rate is the rate banks pay to borrow directly from the Fed. The Federal Funds Rate is the overnight bank lending rate that affects how much interest consumers pay on credit cards, lines of credit, home equity loans, auto loans, etc. These are not mortgage rates. These rates have a direct effect on the Prime Rate (normally 3% above the Fed Funds Rate) but no direct effect on mortgage rates. The Prime Rate is important because many banks use it to determine the rate for short term loans such as land loans, interim construction loans (used to build a house) and business loans. The Fed normally only changes rates once a month. They are reacting to what has happened according to several economic reports. The Fed does not have direct control over mortgage rates. Mortgage rates are actually based on Mortgage Backed Securities (MBS) which are bonds issued by Fannie Mae and Freddie Mac. The trading performance of those bonds determines the direction of mortgage rates.

If the Fed does not control mortgage rates, who does and how can I know if mortgage rates are going down or up? There are several economic reports which are published each month that show what has happened with the economy. These reports are used to give an indication of what the economy is going to do in the future. When the economy appears to be improving, money managers tend to move their money into stocks and the demand for stocks drive the price of stocks up. When the economy appears to be declining, money managers tend to move their money into bonds because bonds are considered to be more secure. When money managers are moving money into bonds, bonds perform better and the price increases. Increased bond prices mean lower bond yields. Normally when someone is talking bonds they are referring to US Treasury bonds. However, as you remember mortgage rates are directly tied to a different bond known as Mortgage Backed Securities (MBS). When the MBS price increases the yield goes down. The lower yield will result in a lower mortgage interest rate. So in simple terms interest rates tend to lower in a declining economy (recession) and interest rates tend to increase in an expanding economy (inflation).

What does the Fed rate have to do with all this? Remember the Fed normally meets once a month. Because of this the Fed is always playing catch up. However, money managers are moving money all the time. They are moving money in anticipation of what will happen in the economy. This causes changes in mortgage rates to occur before the Fed changes their rate. The Fed adjusts rates based on what has happened. The Fed tries to keep the economy at a steady growth of about 3%. If the economy appears to be growing slower than 3% the Fed may drop rates to boost the economy by making short term money cost less. If lowering the Fed rate causes the economy to improve, mortgage rates may actually go up. In a follow up article I will discuss in more detail several indicators that you can watch to get an idea of what the mortgage rates will do.

George Lourigan can be reached at George@HomeLoanHeaven.net or 512-635-3229.

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