Impact of Federal Reserve Interest Rate Cuts on Fixed Rate Mortgages

(January 18th, 2008)

The US Federal Reserve cut its Federal Funds rate to 4.5% on October 31st, 2007 and further cut those rates to 4.25% on December 11th, 2007. The federal funds rate is the rate at which depository institutions (banks and other financial institutions) lend money to each other via overnight loans. The Federal Funds rate is an open market operation that the Federal Reserve Chairman Ben Bernanke uses to to control the money supply in the US economy.

Now that the Federal Funds rate is at 4.25% and it is expected that the Fed will further cut interest rates to 3.75% on January 31st, 2008, how does this impact the fixed interest rates on mortgage loans? Unfortunately, interest rates on fixed mortgage loans will not be impacted much, if at all. The new 4.25% interest rate will favor those people who are borrowing short term loans such as personal loans, payday loans, auto loans, etc. However, bigger factors such as inflation, trends of the US stock markets (the Nasdaq and the New York Stock Exchange), the money supply in the US as well as purchasing power of individual US consumer play a huge role in setting long term mortgage interest rates.

The cost of an Average 30 year fixed-interest mortgage has dropped half a percentage point (0.5%) since the Fed starting cutting rates on October 31st, 2007. But there is little chance this rate will go further lower. Infact, Freddie Mac (the large government controlled mortgage financing company) and the National Association of Realtors have said that interest rates on 30 year fixed term loans will cost an average of 6.5% in 2008. This clearly indicates the Fed's rate cutting plans will not have an impact on long term mortgage loans.

This is contrary to what is actually happening in the market. Infact according to the Wall Street Journal (January 18th, news edition), interest on the 30 year fixed-rate mortgage loan was 5.69%, down from 6.23% in 2007. 15 year fixed-rate loan was at 5.21%, down from 5.98% a year ago. Also, the five year Treasury adjustible rate mortgage (ARM) averaged 5.40%, down from 6.04% in early 2007. This is telling us that indeed the Fed's Federal Funds rate cutting campaign is also helping lower interest rates on fixed 15 and 30 year loan terms.

Frank Nothaft, chief economist at Freddie Mac quotes, "The latest retail sales report indicated that shoppers scaled back spending in December. The declines aggravated concerns about the well-being of the economy and exerted downward pressure on mortgage rates."