The Fed Lowered Rates. Why Didn’t Mortgage Rates Go Down?

It is a common misconception among the American public (and even some folks in the financial world) that the Federal Reserve controls mortgage interest rates. Every time the Fed lowers rates, which of course has happened several times as of late, mortgage bankers and brokers are flooded with calls from clients looking to take advantage of the lower 30 year mortgage rates they just heard about on the news. The problem is that the Fed-controlled rates and mortgage rates are “apples and oranges”- two completely different things.

What does the Fed Control?

The Federal Reserve controls two important interest rates- the discount rate and the fed funds rate. The discount rate is the interest rate at which the Fed lends money to banks. The Fed funds rate is the interest rate at which banks lend money to each other. The prime rate is a term which most consumers know. The formula for the prime rate is the fed funds rate plus 3 (currently 5.25%). This affects many consumer lending products- home equity lines, auto loan, credit cards, etc. When you hear on CNBC that Ben Bernanke just lowered interest rates- this is how it will impact the consumer directly (and a few other ways indirectly).

Where do mortgage rates come from?

Mortgage interest rates come from one place- the buying and selling of mortgage bonds (aka mortgage backed securities or MBS) – not from the 10 year T-bill, not from the Fed.
There are many buyers and sellers of these mortgage bonds such as banks, large mortgage lenders, Wall Street firms and foreign investors. The price at which these bonds are trading is what determines mortgage interest rates. It fluctuates constantly throughout the day, just like the stock market. Every mortgage company re-prices their mortgages each morning and sometimes a few times during the day, depending on what is happening in the market.
In fact, mortgage rates often rise when the Fed lowers rates

There are a couple reasons for this, involving both long and short term factors. Short term effects: Most people know that the stock market rallies when the Fed lowers rates. Stocks and bonds are competing for the same investment dollar. When money flows into stocks it is coming out of the bond market. When money flows out of the mortgage bond market it causes the prices to drop and the interest rates to rise. It often swings drastically during that trading day. Imagine the customers’ surprise when they just heard the Fed lowered rates and they call up their mortgage banker only to hear that the mortgage rates are higher than yesterday! Hopefully the mortgage consultant will explain why and prepare the customer for the next Fed meeting. Long term effects: Lower fed rates cause inflation worries. Bonds hate inflation because it can erode their value in the future (eg. a 6% bond isn’t doing much for you if annual inflation is 4%). If the bond market hears talk of inflation they are going to sell off, again causing prices to go lower and rates higher.

So don’t assume that mortgage rates are moving along with the Fed rates. They are two different animals entirely. Unfortunately the news doesn’t report this accurately and it costs many consumers money because they aren’t able to make informed decisions. It’s our job as mortgage, real estate and finance professionals to point clients in the right direction.

by:  Chris Haddon, Hard Money Bankers, LLC