3/16/2020 | Casey Fleming | The quick answer is “no.” “The Fed” is shorthand for the Board of Governors of the Federal Reserve Bank. Yesterday the Fed reduced short-term rates. What’s the difference? I explain this thoroughly in my article from August 1 of last year, Does the Fed Rate Cut Affect Mortgage Rates? The essence of the article is that the Fed does not control mortgage rates, although they can influence them – but not by lowering short-term rates.
So, when you heard yesterday that the Fed reduced the target rate from a range of 0.50% to 0.75% to the new range of 0.0% to 0.25%, you might have had the thought that this would be a great time to refinance. It is, but not for that reason, and it’s important to understand the distinction.
The only thing that controls mortgage rates is competition among lenders for your business. The two most important considerations that drive what they want to charge are their cost of funds, and their capacity for more business.
Cost of Funds
The cost of funds is important because lenders have to earn a profit, and they obviously won’t charge you a lower interest rate than what they must pay on the money they borrow for the purpose of making mortgages. On the vast majority of mortgages in the U.S., this means that Fannie Mae and Freddie Mac decide what yield they need to earn, and thus set the interest rate for the pool of money almost all lenders draw from. (Non-conforming loans work similarly, but Wall Street hedge funds “set” the rates the same way Fannie and Freddie do.)
Where do Fannie and Freddie get their money? From institutional investors who buy mortgage-backed securities. These institutions compare the risk and return of investing in a pool of mortgages to other investments they might make, like U.S. Treasury Bonds or stocks. They compete with each other to purchase mortgage-backed securities, so the market essentially sets mortgage interest rates.
Today the cost of mortgage funds is the lowest we have ever seen. So why aren’t mortgage rates the lowest in history?
The depth of the drive for safe-haven investments has taken most everyone by surprise. While purchase activity is up slightly, refinance activity is up by about 600% compared to a year ago. Lenders did not staff up for this kind of surge in business. They simply cannot process all the applications they currently have.
So, lenders have no incentive to lower prices, despite having the lowest cost of funds in history. They are simply making a much higher profit on each loan, and working through the system as fast as they can.
And Then There’s QE5
Remember all the talk about Quantitative Easing a few years ago? In addition to lowering the short-term rates, the Fed committed to buying $300 Billion of U.S. Treasury Certificates and $200 Billion worth of mortgage-backed securities in order to drive the cost of funds down in the hope that lenders will pass on the savings to consumers. Remember I mentioned that the Fed doesn’t control mortgage rates but can influence them – this is how they could do it.
“But wait,” you exclaim. “If the cost of funds is already at historic lows and lenders are holding their mortgage rates up anyway because they can’t process all the loans they already have, what good will that do?”
You are wicked smart.
Until lenders work through the surge in their pipeline, we won’t see lower mortgage rates. In my experience, this will take at least a month, possibly as long as three. If the mortgage-related cost of funds stays low long enough, once lenders work through the bulge in their pipeline, competition will drive mortgage rates down. Since lenders are staffing up and expanding their production capacity, rates could go way down, but again – the historically low cost of mortgage funds will have to hold long enough.
We shall see.
For now, mortgage rates are within a hair’s breadth of all-time historic lows, so if you know you want to refinance, but don’t want to roll the dice and hope that rates will come down further, it is an excellent time to refinance. Call me to find out what we can do for you.
Target Rate: https://www.investopedia.com/terms/t/target-rate.asp
Mortgage-Backed Securities: https://www.thebalance.com/mortgage-backed-securities-types-how-they-work-3305947
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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