Understanding Mortgage Rates

Written by:  Glenn B. Bartholomew

Every day I am asked if the interest rates for home mortgages went down.  Every time the Federal Reserve has changed the short-term bank borrowing rate, I get many phone calls asking me about what the new mortgage rates are and how low or high they are going to go.

It’s time to help everyone understand the differences between short-term interest rates and the long-term interest rates.  I apologize for not getting to his sooner.

The Federal Reserve just recently increased the short-term interest rate, but interest rates have barely moved, not to mention initially went lower.  Remember this:  The Federal government controls short-term interest rates, but do not control long-term interest rates.

Most people believe that the short-term and long-term rates are the same or are in tandem.  Nothing is farther from the truth.  What the Federal Reserve controls directly are the federal funds rates.  This is what the media is always referring to when they say Ms. Yellen is either raising or lowering the rates.  This is the rate that banks charge each other for overnight loans.  Some of these areas that are directly and quickly influenced are credit card rates, auto loans and any other loans that are short-term (less than 10 years).

The Federal government can and does influence long-term rates, but DOES NOT have any direct control over them.  The reason for this is that mortgages are long-term loans heavily influenced by long-term rates.  Especially the rate of the 10-year U.S. Treasury securities.

The bottom line to all of this is quite simple.  The stock market loves short-term rate cuts, but the long-term bond market hates them.  When short-term rates are cut, you are adding to the money supply, that has the potential to become inflationary.  Long-term lenders have a fear of inflation that will eat away at the value of their money.

The beneficiaries of short-term rate cuts are banks, which borrow very large amounts of short-term money, much of it to fund high-interest credit card loans.

Long-term rates are also important.  Rising long-term rates undermine the effect of falling short-term rates.  A good example of how all this goes full circle is that one of the major factors stimulating consumer spending on big-ticket items like cars (short-term finance rates), has been the money homeowners are taking out of their houses by refinancing or taking out second mortgages (long-term interest rates).  If the refi market or purchase market is slowed down by higher mortgage rates, or no mortgage rate reduction, consumer spending could be hurt.

So you see, the Federal Reserve isn’t the most all-powerful person the media tries to make us all believe they are.  They cannot cut short-term interest rates blithely.  They have to worry about the long-term bond market as well.  All this while trying to stimulate the economy, short-term.

A hat tip to Glenn B. Bartholomew for providing this easy-to-follow understanding of market interest rates.

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