By HOLDEN LEWIS
bankrate.com
Thursday, September 20, 2007
Yes, the Federal Reserve cut short-term rates. No, that doesn't mean that mortgage rates will inevitably go down, especially in the short term.
A look at mortgage rates must begin with a history lesson. From Jan. 3, 2001, to June 25, 2003, the Federal Reserve reduced its target for the federal funds rate 13 times. Here's what happened to the average 30-year mortgage rate in the month after each cut: It fell eight times and rose five times. It's simply not true that a Fed rate cut automatically leads to a drop in fixed mortgage rates.
Because this point is so widely misunderstood, mortgage people wax passionately about it. Such is the case for Dan Dowling, president of United Mortgage Capital Corp., in Altamonte Springs, Fla., who declares emphatically, "There is zero causation between mortgage rates and the Fed reducing its target for the federal funds rate."
Whenever the Fed cuts the federal funds rate, customers call mortgage lenders, eagerly expecting to take advantage of a drop in mortgage rates. By the time these phone calls are over, customers frequently feel disappointed and even suspicious. It just doesn't seem right. Why would banks raise mortgage rates while the Fed is cutting rates?
Things aren't that simple (or that sinister). Mortgage rates go up and down according to investors' expectations of long-term inflation. Simply put: If investors think inflation will accelerate, mortgage rates (and other long-term interest rates) rise.
The nation's overall economy doesn't appear to be in recession (although the housing sector, and some Midwestern states, might be). Yet the Fed added some stimulus by cutting the federal funds rate. That, in turn, could lead to faster-rising prices and, therefore, higher long-term interest rates.
Mortgage rates often anticipate Fed rate moves instead of reacting to them. Just two months ago, in mid-July, the average rate on a 30-year, fixed-rate mortgage in Bankrate.com's weekly survey was 6.82 percent. This week, it was 6.32 percent -- exactly half a percentage point lower. And the Fed just reduced the federal funds rate by the same margin of half a percentage point.
Dowling says that when you see mortgage rates declining, they're reacting to market forces -- and the Fed eventually plays catch-up. "The Fed didn't cause the decline (in mortgage rates), which already took place prior to them lowering the rate," he says.
Bob Walters, chief economist for Quicken Loans, agrees that fixed-rate mortgages "priced a lot of this move in." He expects long-term mortgage rates to remain stable, unless the overall economy stumbles. Starting rates on adjustable-rate mortgages will drop, Walters says, because they're more sensitive to Fed rate moves.
From Walters' perspective, the most welcome change will happen in bank-to-bank lending. There will be more of it, which will "un-seize" the jammed credit markets that have made it hard to find a jumbo mortgage in the last couple of months. Jumbo mortgages are home loans exceeding a "conforming limit" that changes annually; this year, the conforming limit is $417,000.
"More people will get loans as a result of this than they could get before this," Walters says.
Dean Baker, an economist with the Center for Economic and Policy Research, in Washington, D.C., doesn't expect much of a break in mortgage rates, either. "Prime mortgage rates may go down a small amount," he says. "But anything that's not prime and conformable -- I'd be surprised if you'd see any downward movements."
The Fed's rate cut "is pushing on a string," Baker says. "It's not going to prevent house prices from falling. Housing construction and home sales and house prices will continue to decline."
Falling house values pose a severe problem for homeowners who made small down payments a few years ago and got adjustable-rate mortgages. Hundreds of thousands of people find themselves in a situation where their ARM rates are rising, yet they can't refinance their mortgages because they owe more than their houses are worth.
But falling prices create winners, too -- especially when mortgage rates are relatively low, as they are now. "You have large chunks of the population who stand to gain from falling prices for real estate," Baker says. "As a broad group, you can say everyone who's a renter and might look, at some point, to buy." This especially goes for young people in bubble markets in Florida, California and the Northeast, where middle-class working people might someday be able to buy houses, if prices fall enough.
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The benchmark 30-year fixed-rate mortgage rose 4 basis points, to 6.32 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of one percentage point. The mortgages in this week's survey had an average total of 0.34 discount and origination points. One year ago, the mortgage index was 6.44 percent; four weeks ago, it was 6.58 percent.
The benchmark 15-year fixed-rate mortgage rose 4 basis points, to 6 percent. The benchmark 5/1 adjustable-rate mortgage rose 11 basis points, to 6.41 percent. On larger loans, the benchmark 30-year jumbo rose 3 basis points, to 7.23 percent.
(Distributed by Scripps Howard News Service. Reach Holden Lewis at hlewis(at)bankrate.com.)
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