So The Fed Cut, Now What?

This week I am pleased to present an opinion of the Fed’s move from the mortgage perspective, and who better to write it than my esteemed colleague, mortgage expert extraordinaire Josh Lewis.

By Josh Lewis, the Fabian mortgage expert

Despite persistent concerns about inflation, the Federal Reserve gave in to the markets on Tuesday and cut both the federal funds rate and the discount rate by half a percentage point. They did so in an effort to bring some liquidity back to the secondary market for mortgages. Their hope is that lowering borrowing costs for institutional investors will trickle down to homeowners in the form of better mortgage rates and terms.

This is critical right now as the housing market teeters on the edge of a major downturn as lenders have cut off funding for risky borrowers eliminating the safety valve for many homeowners with “exotic” adjustable rate loans that will soon, or have already, reset to much higher market rates. Now I realize this is an oversimplification of the issue, but for our purposes it sets the stage for what really matters, which is what does the Fed’s actions mean for you?

First off, let’s discuss what a Fed cut does and does not mean for the mortgage markets. Any time the Fed cuts the federal funds rate, I get several calls from borrowers and prospects who want to know how much better rates are. What usually happens is we see a knee-jerk reaction of improved rates followed shortly after by an uptick.

The reason that mortgage rates move in the opposite direction of Fed policy is that inflation is still the arch enemy of mortgage bond holders. Inflation eats away at the value of their investment. Fed cuts are seen as inflationary, while a rate increase is viewed as likely to decrease inflation, which maintains or increases the value of mortgages in an investor’s portfolio.

What this means is that we may give back some of the recent improvement in mortgage rates as the markets had largely priced in Tuesday’s cut. Over the next two-to-three months the markets will be closely watching inflation figures. If they remain tame, increasing the possibility of further rate cuts, we will see mortgage rates improve. If inflation signals rear their ugly head, mortgage rates will worsen as the markets realize more cuts won’t be coming, and as the value of fixed-rate investments decrease.

One group of people who directly benefit from the Fed cut is homeowners with home equity lines of credit. The vast majority of these loans are tied to the prime rate, which moves in lock step with the Fed Funds Rate (+3.00%). Most well-qualified borrowers pay close to prime for their HELOC rate. Tuesday’s cut means their rates dropped from 8.25% to 7.75%. Those rates don’t look so great when you consider that most folks took out their lines of credit in 2003 and 2004 when prime was as low as 4%, but hey, every little bit of interest saved helps.

In the bigger picture, what will the rate cut mean for the real estate market? Unfortunately, not much.

Interest rates in and of themselves have very little correlation to real estate prices. Historically, home values have done best when rates are increasing (the 2000-2005 boom is the first period of rapid real estate appreciation to occur in a decreasing rate environment). Additionally, the troubles in the real estate markets are most closely tied to a lack of affordability.

When lenders eliminated many teaser rate programs and required borrowers to start documenting income, the market of potential homeowners able to qualify for financing greatly decreased. At the same time, speculators have been heading for the exits by putting properties up for sale or losing them to foreclosure, increasing supply and reducing a large source of “artificial demand.”

What does all of this mean for you? If you have a HELOC on your property, you will be paying less in interest next month. If you are looking to buy a new home, rates are at their best levels in about a year, but qualifying guidelines are still very tight. If you are a home seller, your potential buyers will be facing the same issues.

At the end of the day, the Fed’s move was, in my opinion, largely symbolic. But even if it’s just a Band-Aid, the message is clear that the Fed is being vigilant and will do everything in its power to help stabilize the mortgage and real estate markets. And right now, that’s about the best we can ask for.

If you have questions regarding your mortgage financing or your real estate, give me a call at 888-944-5674 ext. 1. I will be glad to go through your situation with you. To send me an email, click here.