Saturday, January 26, 2008

Misconceptions About Mortgage Rates' Driving Forces Can Cost Borrowers

Each time the Federal Reserve cuts interest rates, borrowers converge upon their mortgage representatives expecting lower interest rates. Unfortunately, they find that mortgage rates often rise after the Fed cuts rates, and those who have held off on refinancing or locking rates thinking a Fed rate cut will reduce mortgage rates, are actually faced with higher rates than before the Fed's rate reduction.

Consumers who are looking to get the best mortgage rates need to understand that the Federal Reserve can only control the discount rate and the Fed funds rate, which are both very different from mortgage rates. Borrowers are constantly mistaken in thinking that rate cuts by the Fed will result in lower mortgage interest rates. That simply isn't the case.

Another common misconception is that mortgage rates are directly related to 30-year Treasury bonds or 10-year Treasury notes. "Both 30- year Treasury bonds and 10-year Treasury notes are government securities and backed by the full faith and credit of the U.S. government. They have no direct effect on mortgage rates.

Mortgage rates are based solely on mortgage backed securities. The trading performance of mortgage backed securities, which are issued by Fannie Mae and Freddie Mac, determine the direction of mortgage rates. Finding the catalyst that causes mortgage bonds to move will give consumers the keys to finding out what makes mortgage rates rise and fall.

Inflation is a key factor in pricing long-term bonds, because inflation erodes future returns. Since bonds pay out a set amount over a long period of time, that amount will be less valuable in future markets, especially if inflation is high. Because bond investors are very aware of this, they will require a higher rate of return or interest on their investment to compensate them if they feel that inflation will be increasing.

To understand the relationship between bond prices and mortgage rates, first put yourself in the position of a mortgage bondholder, like a mortgage lender. If it looks like inflation is going to cut away at the value of your bonds, you'll need to charge more interest on the mortgage loans you generate in order to compensate for that lowered value on the bonds. So if you anticipate increases in inflation, perhaps caused by the Federal Reserve lowering rates, you'll probably be raising mortgage rates in response. Therefore, because rate hikes by the Fed are designed to slow inflation, that is actually very good news for bondholders or mortgage lenders. A Fed rate hike can actually help reduce mortgage rates.

The Fed's rate cuts stimulate the economy by making borrowing cheaper, which in turn gives vendors the ability to increase prices. That leads to inflation, which erodes the value of long term bonds and more specifically, of mortgage bonds. When MBS values are in jeopardy, mortgage rates tend to rise.

While these key factors are better indicators of mortgage rates, borrowers and homeowners should remember that there is no surefire way to predict the market.

Keep an eye on the MBS market, but also bear in mind that the best rates may be behind us. Mortgage rates are still low, and we could see some quick dips. Borrowers should always consult a qualified mortgage planner who can advise on any market changes. If you're looking to refinance, be prepared to act, so you can make the most of any lower rates while they last.


Anonymous said...

Who should I get in contact with about a states own laws about mortgage broker bonds and as such, how would I get a mortgage bonds form? I life in England and am considering moving to America, don’t know where yet however I was doing some general reading about housing and came across the term mortgage broker bonds and am a little confused, is it a mortgage or a loan to acquire a mortgage?
Also if I want to set up life insurance do I need insurance bonds? Or can I simply open a policy with a company? I’m a little confused by some of the jargon. I am not moving anytime soon but thought I should be aware of things I will need to understand.

jon said...

Can you tell me what Surety Bonds are? I have heard of Corporate Surety Bonds but I don’t understand what they are, can you help?