Every time the Fed lowers rates, our phones ring! Everyone thinks that means mortgage rates are going down…when in fact, that is usually the opposite of what happens. And unfortunately, most loan officers do not even understand the relationship between the Fed funds rate and mortgage rates.
What you need to know
The Fed rate cut does not translate to mortgage rates dropping. The Fed cutting rates means that the Fed is trying to stimulate the economy and spark inflation. Investors in longer term maturity bonds, like mortgage bonds, hate inflation because it eats away at or erodes the payment the investor is receiving. See, the bond holder is getting a fixed payment every month for a long period of time, and if inflation is on the rise, that means the bond holder’s buying power diminishes over time as the cost to buy goods and services increases. Therefore, the Fed cutting rates is typically not a good thing for mortgages unless the inflation element is viewed as being benign.
Where it could help to save you money
You could see a savings on short term loans such as second lien home equity loans or home equity lines of credit that are tied to shorter term rates.
It’s a balancing act
Since the Federal funds rate is used to achieve the Fed’s goals of price stability and sustainable economic growth, changing the Federal funds rate influences the money supply, beginning with banks and eventually trickling down to consumers.
The Fed lowers interest rates in order to stimulate economic growth. Lower financing costs can encourage borrowing and investing. However, when rates are too low, they can spur excessive growth and perhaps inflation. And explained above, inflation eats away at purchasing power and could undermine the sustainability of the desired economic expansion.
On the other hand, when there is too much growth the Fed raises the Federal funds rate. Rate increases are used to slow inflation and return growth to more sustainable levels. Rates cannot get too high, because more expensive financing could lead the economy into a period of slow growth or even contraction.
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