Franklin Financial Group Blog

As of Wednesday, January 31st 2008, the Fed has reduced rates twice in 30 days.  The total reduction has been 1.25%.  After the first 0.75% rate reduction my phones started to light up. After this second 0.50% reduction, my phones started to blow up!  The single most predominant question was where are mortgage rates. Many people are under the misconception that rates should have dropped by 1.25% as well.  While that would be wonderful for mortgage professionals nationwide, this has not been the case. Often you will actually see mortgage rates rise when the Federal Funds Rate drops.

Let me first explain what the Federal Funds Rate is. The Federal Funds Rate is the interest rate which a depository institution lends funds to another depository institution, or simply the interest rate on overnight loans between banks. This information was obtained from http://www.econmodel.com/classic/terms/fedfunds.htm. The Federal Reserve mandates that banks must keep a certain amount of cash, or reserve balance, on deposit at their local Federal Reserve branch office at all times.

An example of how the Federal Funds Rate works is that when the Federal Funds Rate is decreased banks lend more money, businesses expand, home loans are cheaper, the housing market improves, and homeowners take out home equity loans. These loans are often used to pay for things such as home improvements and new cars, stimulating the overall economy. This information was obtained from http://useconomy.about.com/od/monetarypolicy/a/fed_funds_rate.htm.

So the question many people have is why haven't mortgage rates dropped to match the reduction in the Federal Funds Rate?  The answer is that the two are NOT directly related to one another. The Federal Funds Rate applies to short-term rates, while mortgage rates are tied to long-term rates. These long-term rates are often influenced by much emotion such as greed or fear. If investors believe a reduction in the Federal Funds Rate is certainly going to boost the economy, then you might see the Stock Market (riskier investments) experience a rise as money is moved from the Bonds and/or Mortgage Backed Securities (more conservative investments) into the Stock Market.  This is also often true when inflation becomes a concern. Conversely, if news hits Wall Street creating feelings that the economy may not be suffering or may suffer in the near future, or that inflation is not as much of a concern as may have been thought, then you often see money transferred from the Stock Market back into Bonds and/or Mortgage Backed Securities. When money flows out of Bonds and Mortgage Backed Securities the price of mortgages (rates) will rise. The opposite is true that when money flows into Bonds and Mortgage Backed Securities the price of mortgages (rates) will fall.

Hopefully this clarifies some of the questions that are out there about how mortgage rates are influenced by the Fed's moves as of late. There is no way to guarantee what rates are going to do. If the recent moves do what they were intended to, and the economy starts to experience growth, you should not be surprised to see mortgage rates rise. 

In conclusion, mortgage rates are currently FANTASTIC!  There is a lot of inventory with regards to homes that are on the market to be sold. Buyers can not only obtain tremendous financing rates, but also may be able to purchase the property at an amazing value. If you already own a home, now may be the perfect time to look into refinancing in order to take advantage of these great rates.