Whenever the Fed raises or cuts interest rates you’ll see a lot of news stories about interest rates, and a surge of advertisements telling you that you should borrow money now, not later. Is there any substance to this? Does the Fed rate cut affect mortgage rates? Let’s take a look.
The Federal Open Market Committee (FOMC) is comprised of the regional governors of the Federal Reserve Bank (The Fed.) They are responsible for making policy decisions with two competing goals in mind: they try to keep inflation in check while keeping the economy growing. If the economy grows too rapidly inflation tends to rise, so these goals conflict with each other. The Fed has to walk a very narrow tightrope to meet both goals.
They use several tools to try to accomplish this. The most common is their control of a short-term rate called the Target Rate. The Target Rate is the interest rate that banking institutions charge each other (or are charged by the Fed) for borrowing overnight.
When the Fed “cuts interest rates” it is the target rate that they are changing. In no other way do they directly control the interest rates banks or lenders charge for loans.
However, when they do cut the target rate it reduces banks’ cost of borrowing short-term money. Consequently, banks reduce short-term rates to consumers, such as credit card rates. This spurs spending by consumers, which generates economic activity and thus gooses the economy by injecting money into it.
So, Does the Fed Rate Cut Affect Mortgage Rates?
In a word, no, because mortgages are not short-term loans. However, it is a little more complicated than that. Mortgage interest rates are driven by the market, which responds to expectations of inflation.
Related: What Drives Interest Rates?
When the Fed cuts short-term interest rates they do so because they believe that the economy is slowing down and that inflation is in check. An interest rate cut is akin to an announcement that they don’t have to fight inflation anymore (for now.)
Large institutional investors who invest in mortgages can then accept a lower yield on long-term investments because they don’t have to worry about inflation.
So, when the Fed cuts interest rates it tends to have a direct, if not immediate, effect on mortgage rates, as long as those investors believe the Feds are still willing to fight inflation should circumstances change.
As a result, what the Fed does in terms of raising or lowering the target rate is often less important than what they say about it when they take whatever action they take. Their comments tell investors what the Fed thinks inflation is going to do in the foreseeable future, and therefore give investors confidence to accept a lower yield, or require a higher one.
How Will the Fed Rate Cut Affect Me?
If you carry balances on your credit cards the Fed rate cut will lower the interest rate you pay. Of course, ideally you would not carry balances on credit cards.
If you are in the market for a car, interest rates on car loans should go down a little.
If you are a small business with a business line of credit, the interest rate on that should go down.
Finally, if you are looking to buy a home or considering refinancing your existing mortgage, the Fed rate cut should have a small downward influence on mortgage rates.
Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, C2 FINANCIAL CORPORATION
My Blog: www.loanguide.com
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This article represents the opinions of Casey Fleming, and not necessarily those of C2 Financial Corp. This analysis was prepared with the best information available at the time it was written. Neither Casey Fleming, nor C2 Financial Corp., have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor C2 Financial Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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