I would like to welcome today's guest columnist, Bert Karrer with Countrywide Home Loans. Bert has worked with many of my clients and would welcome the opportunity to speak with you about your mortgage needs.
How does the lowering of Prime Rate affect you and your Mortgage?
In order to answer this question, it is helpful to understand two major interest rates that are affected by the Fed:
Fed Funds Rate (currently 4.5%) - the interest rate that banks pay when they borrow money from each other here in the US. This rate is also determined by the Fed because banks in the US are part of the Federal Reserve System. You see, the Fed’s main role is to maintain “monetary stability” by keeping a close eye on the flow of money throughout the economy. One way they do this is by regulating the interest rates that banks charge each other for short term funds.
Prime Rate (currently 7.5%) the Fed Funds Rate + 3; this is the base rate that is used for most consumer loans such as credit cards and home equity lines of credit, as well as most small business loans. Like the LIBOR, the Prime Rate is also tied to the Fed Funds Rate.
In response to the economic slowdown that has occurred due to the current credit crisis, the Fed lowered the discount rate several weeks ago and they lowered both the discount rate and Fed Funds rate on September 18, 2007 and again on October 31, 2007. Does this mean that more rate cuts are on the way or should we expect that the Fed will sit tight now that they have taken some action?
This largely depends on whether inflation remains under control.
You see, as the Fed lowers the Fed Funds Rate, the business and consumer-based interest rates of LIBOR and Prime will also go down. The Fed would be reluctant to continue lowering rates if they feel that businesses and consumers would start borrowing and spending so much money that inflation will go up significantly.
Remember, the Fed’s main goal is to “maintain monetary stability” by keeping a close eye on the flow of funds in the US economy. It would be reckless of them to artificially encourage too much borrowing and spending as this would only artificially drive up asset prices and cause money to lose its purchasing power. This phenomenon is known as “inflation.” The good news, however, is that inflation seems to be under control based on some of the latest economic reports.
How does the Fed affect mortgage rates?
Well, if you have a home equity line of credit based on Prime or short term ARM’s based on LIBOR, you should see an immediate reduction in your interest rate in the coming weeks. However, if you are considering a fixed rate loan or longer term ARM with a fixed period of 3, 5, 7 or 10 years, rates on those types of loans are not directly related to the Fed. Instead, these rates are closely tied to the Mortgage Backed Securities that trade on the bond market. See the historical chart below for illustration.
As you can see the effects of The Fed don’t necessarily mean lower interest rates on the most popular fixed rates.
With all this in mind, it is more important than ever to work with a professional mortgage lender who can decipher market conditions and help you make informed decisions in today’s volatile market. A professional can look at Fed decisions and economic reports that are coming out and help you make the right mortgage choices. Whether you have or are considering an ARM or a fixed rate loan; whether you are buying, selling or refinancing a Greenville South Carolina area home; whether you are dealing with a primary, vacation or investment property; now is the time to be dealing with an expert.
Countrywide Home Loans