Feb 08 2008
How does the Fed Rate impact Mortgage Rates?
In hope of thwarting a recession, the Federal Reserve took strong steps in the last 2 weeks: a 0.75% emergency interest-rate cut followed by another 0.5%, bringing its target short-term rate down to 3.0%. For mortgage holders, this is mixed news. On one side, the drop in rates will ease some homeowners’ mortgage pain. But it will also reduce savings rates. Here’s what to expect:
Mortgages
Mortgage rates have declined significantly since the Fed started cutting rates in September. But that has less to do with the Fed’s moves than with disappointing economic news.Fixed-rate mortgages are pegged to Mortgage-Backed securities (bonds) and thus are dependent on long-term economic expectations rather than short-term rates. Thanks to bleak economic forecasts, mortgage rates have dipped below 6%.Fixed-rate mortgages are within shouting distance of their 40-year lows. The average conforming 30-year fixed loan was 5.55% as of Thursday, down from 6.4% shortly after the Fed’s first rate cut in the fall.
For prime borrowers — those with good credit, at least 10% equity and the assets and income documentation necessary to refinance — this is a perfect opportunity to refinance into a lower rate. Borrowers whose adjustable-rate mortgages, or ARMs, are about to reset can breathe a sigh of relief. A homeowner with a 5/1 ARM (a mortgage that has a set interest rate for the first five years and adjusts annually thereafter) will now be looking at a 5.8% rate. Those with a reset last September saw their rate jump to 6.9%. The average rate for new conforming 5/1 ARMs has slid to 5.2% from 6.4% at the end of September.Even subprime borrowers may see their loans reset significantly lower. That’s because the index used to determine their rates, called LIBOR, or London Interbank Offered Rate, has dropped thanks to recent efforts by the Fed and overseas central banks to provide more liquidity in credit markets. As recently as September, you’d have had a rate reset to the mid 9% [range]. Your new rate now would be somewhat just over 7%.
Home Equity Loans and Lines of Credit
Folks who have a home-equity line of credit, or HELOC, have seen savings as a result of the Fed’s cuts and will see more with their next statement. HELOCs are pegged to the Prime Rate (currently 6%), which moves in step with the Fed’s target rate (Prime Rate is Fed Rate plus 3%), and they have the most direct relationship to the Fed’s recent rate drop. Home-equity loans, on the other hand, carry fixed rates, so homeowners with these loans won’t see a change. Future home-equity-loan borrowers, however, may see more attractive interest rates as banks lower the rates they charge.
Doug Amend, CMPS®
Mortgage Consultant
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