Mortgage Confidential: Why haven't rates dropped more?

Mortgage expert David Reed invites Walletpop readers to ask him questions about real estate financing. leave your questions in the comment section of this post.

Q: The Fed has reduced rates by three full percentage points since last September. I have been following long term mortgage rates for quite some time. 15 and 30 year fixed rate mortgages are only .25% lower than they were last September. No one I ask seems to know why mortgage rates are still so high and happen to be rising as I write this. The current yield on the 10 year bond is 3.83, up from 3.47 early last week. My question is this. Do you think we will see lower mortgage rates in the future? - Carl

A: Carl -- good question. No, I really don't see lower rates in the future, certainly not anything like three percentage points. If 30-year and 15-year fixed rates do fall they might go down another 1/4 to 1/2% but nothing near to what the Fed has done with the Fed Funds Rate.

The fact is that the Fed has very little to do with fixed mortgage rates. Surprised?

Fixed mortgage rates are directly to to their respective mortgage bond, which are traded all day long. They're then securities backed by mortgages (mortgage-backed securities). The Fed reduces the Federal Funds rate, which is a very, very short term in overnight. This rate is what banks pay for short term loans, typically in order to meet their reserve requirements. The Fed can raise or lower this critical rate to make money more or less expensive. The lower the rate, the increased likelihood banks will lend money to businesses which theoretically would stimulate the economy.

During economic downturns, like we're experiencing now, the Fed will act to make money less expensive by lowering the Fed Funds rate. 30 year fixed rates are not tied to overnight lending rates but to their associated mortgage bond, or specifically a Fannie Mae 5.50% 30 year bond or a Ginnie Mae 6.00% bond. Since bond values are susceptible to inflation, any indicator of inflation will eat away at the future value of a mortgage bond. Prices for those bonds would then fall which would raise the rate.

Inflation can occur when economies are running at full speed and demand for products and services rise. Inflation can also occur when the cost of money is so cheap the currency is devalued, like we're experiencing now. Fixed mortgages rates anticipate the likelihood of inflation.

So while the Fed indeed has dropped the Funds rate by 3%, fixed rates have remained relatively stable. You can find more information in my book, Mortgage Confidential.

Real estate finance expert David Reed is president of CD REED Mortgage Bankers in Austin, TX and author of Mortgage Confidential: What You Need to Know That Your Lender Won't Tell You and Mortgages 101: Quick Answers to over 250 Critical Questions About Your Home Loan.

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