How do Federal Reserve decisions to raise or lower interest rates impact the mortgage market?
The Federal Reserve controls two important rates: First there is the “federal funds rate– — the interest level banks can charge each other for the use of money overnight. Second, there is the “discount– rate — that’s the cost banks pay to borrow directly from the Fed.
In effect, the Fed does not control long-term mortgage rates. Instead it impacts short-term credit by limiting or expanding funds available through the banking system. It makes such decisions in response to what it sees as the potential for inflation, deflation and other factors.
Fed decisions impact stocks and bonds. Since many investors can choose between putting money into stocks, bonds or mortgages, home loans can reflect such changes. For instance, if rates for 10-year bonds rise, mortgage rates are also likely to increase. Why? Because if mortgage rates do not rise investors will move their dollars into 10-year bonds and away from home loans.
Investors are interested in 10-year bonds and not 30-year bonds because most mortgages do not last three decades. Instead they’re usually paid off in a decade or so — or at least that was the pattern before the recent decline in mortgage rates, a time when many borrowers financed and refinanced within a year to get the lowest interest costs.
The Federal Reserve Bank of St. Louis has a good explanation, in plain language, which shows how the system works. For details, see: http://www.stlouisfed.org/publications/pleng/default.html
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Syndicated originally by Content That Works and posted with permission.
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