Over the last month you have seen the news about the
Federal reserve cutting the interest rates. Every time this
happens I get hundreds of calls, from old clients of mine,
wondering what the rates are at? What they don't understand
is that the news media is getting this completely wrong.
Many people and news experts have a misunderstanding about
the change in the federal funds rate and how it affects
mortgage rates. Not understanding this can cost you a lot
of money on a 30 year mortgage. You need to have an
understanding that the Federal Reserve does not determine
mortgage rates.
Let me explain how mortgage rates are determined.
Basically, when you take out a mortgage, the bank or
mortgage company is making you a loan at a given interest
rate. Sometimes the firm that makes the loan holds onto it,
like a local bank. But more often than not, the lender or
mortgage company sells that loan to an institution that
packages it with other mortgages into what's known as a
mortgage-backed security and then sells that security to
investors. That investor, whether it's a mutual fund or a
large institutional investor, earns a return by collecting
the principal and interest payments that you and all the
other mortgage borrowers make. To get those investors to
buy the mortgage-backed securities, they must pay a
competitive interest rate compared to investments like a
treasury bond. The average loan lasts for about ten years
so an investor compares the mortgage-backed security to a
10-year Treasury note. Of course we are not as good a risk
as the government so rates on mortgages are going to run
about 1.7% higher than the 10-year treasuries. Now this
investment is competitive in the market and people will
invest in it.
The next factor that can really affect rates is inflation.
Lets say you are going to invest into one of these
securities and planned to hold onto it for ten years.
Inflation in the next ten years could dilute the actual
value of payments received from these securities. As a
general example you are at 6% on your security but
inflation is growing at 3%, your "real" interest rate
return is only 3%. Therefore if inflation is expected to go
up so will interest rates. The other side of the coin is if
inflation is expected to go down then rates should follow
suite.
These are the two main factors in determining mortgage
rates but other factors are involved. Too many factors to
be explained in such a small article. The bottom line
people want to know when are rates going to drop so I can
refinance? "Unfortunately, there's no tool for predicting
the future path of rates. Doing so would require that you
be able to take into account the myriad factors that
determine rates -- the health of the economy, the outlook
for inflation, the flow of investors' money between stocks,
bonds, mortgage-backed securities and other investments --
and translate all those factors into an accurate prediction
for rates." said expert Walter Updegrave, Money Magazine. I
agree, the only thing you can do is stay on top of your
broker or bank and lock that rate when you feel comfortable
with it. Always get the rate lock in writing in case of a
discrepancy.
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David Forer is a financial veteran of 15 years. To tap into
his knowledge about credit repair, debt management, and
budgeting go to his blog at
http://www.creditrepairdoneeasy.com or
http://www.squidoo.com/milwaukeemortgage to receive a free
ten page report.
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