Mortgage Rates, Explained
The US is experiencing wild day-to-day fluctuations in financial markets. Headlines include massive federal stimulus and news that the Federal Reserve has cut interest rates to zero. If you have applied for a mortgage, what does this mean for you? We have been fielding a lot of these questions, and hope the explanation below helps.
Federal Reserve Action
The Federal Reserve controls something called the Fed Funds Rate. The Fed Funds Rate is the interest rate at which banks and depository institutions lend to each other. Think of this rate as a lever which the Federal Reserve uses to either stimulate or cool off the economy. A reduction in the Fed Funds Rate is designed to make borrowing attractive and stimulate spending. Financial markets usually respond favorably (stock market goes up), and the action makes the news.
The Federal Reserve cut their Fed Funds rate to zero last weekend, primarily to ease market volatility. In a perfect world this would have had both a financial and psychological effect. This didn’t happen. Financial markets remain volatile. The rate cut will still reduce borrowing costs for certain types of consumer debt - primarily car loans, credit cards, and home equity loans.
How This Impacts Mortgage Rates
When you borrow money, the lender is usually an intermediary between you and an investor lending to earn a return (profit). That investor is likely investing in or creating large pools of that type of debt. These pools of debt are called bonds. Money lent for a mortgage is commonly pooled into a specific type of bond called a mortgage backed security (MBS). The demand for these MBS bonds determines mortgage rates on a daily basis. If there is increased demand for MBS bonds, rates go down. If there is decreased demand for MBS bonds, rates go up. These fluctuations go on all day every day.
Normally, the economic conditions that result in the Federal Reserve lowering the Fed Funds Rate translate to more demand for mortgage backed securities and lower mortgage rates. It’s not a direct effect, but a correlation.
The current volatility in financial markets is unprecedented, and has resulted in less demand for mortgage backed securities than we would expect with these conditions. There are a few additional dynamics, but this is the crux of the gap between what is happening with rates, and what a borrower might expect.
What Does This Really Mean For You?
While mortgage rates may not be zero, they are virtually as low as they have ever been. If you are in the market to purchase or refinance a home, this is a great time to take advantage of these historic lows.