Tuesday March 18, 5:01 pm ET -
By David Goldman, CNNMoney.com staff writer -
The Federal Reserve cut interest rates by three-quarters of a
percentage point Tuesday, but don't expect mortgage rates to go down
too. In fact, home loans could be heading higher.
Consider recent history: The Fed issued an emergency cut of short-term
rates in early January, and then trimmed more just a few days later -
but the 30-year fixed mortgage rate has responded by bouncing up from
5.6% to 6.4%.
The Fed's main tool is control over the short-term fed funds rate,
which determines what banks charge each other for overnight loans.
Long-term mortgage rates are mostly tied to the 10-year Treasury
yield, which is determined by bond traders worldwide.
"There is a long disconnect between the fed funds rate and fixed
mortgage rates," said Keith Gumbinger, vice president of mortgage and
consumer loan information publisher HSH.com.
Inflation drives long-term fixed rates. When the Fed cuts short-term
rates, the intent is to lower borrowing costs for cor****ations so that
they'll invest and hire. But this economic growth can lead to
inflation.
That in turn leads bond traders to demand higher rates on their long-
term bonds - and that drives up mortgage rates too.
"Mortgage rates are determined by how fearful the market is of
inflation," said Gumbinger.
The Fed began a series of cuts to its key interest rate last
September, taking the rate to 2.25%, from 5.25%.
ARM borrowers may get help. There is more of a connection between Fed
rate cuts and short-term and adjustable rate mortgages (ARMs). In
fact, homeowners with ARM loans could see lower rates from further
interest rate cuts.
Adjustable rate mortgages are pegged to a number of different indexes,
including the one-year Treasury yield and the international Libor, or
London Interbank Offered Rate, which tend to move with the Fed funds
rate.
With Tuesday's rate cut, the ***ulative effect of the Fed cuts could
entirely offset what would have been a significant rate reset for many
homeowners.
For instance, a borrower with an adjustable rate of 4.5% could have
faced a rate reset up to 7.5% before the Fed started cutting rates in
September. Before the rate cuts, that homeowner would have seen an
increase of $370 in monthly payments on a $200,000 loan.
But after Tuesday that rate could reset only a little higher. And for
some, the rate might not go up at all - and may actually drop -
according to Greg McBride of Bankrate.com. "The Fed rate cuts far are
more significant to [borrowers with ARMs] in terms of staving off
delinquencies on loans," he said.
Long-term rate solution. Sending long-term fixed rates back down will
be more complicated than fixing inflation, because the continuing
housing crisis is also exacerbating the rise in long-term fixed rates.
Generally mortgage rates are about 2 percentage points higher than the
yield on the 10-year Treasury, which currently stands at 3.29%.
But the housing market is in such turmoil that rates are even higher
right now, with lenders concerned that borrowers will not be able to
pay back loans.
"The 30-year fixed rate mortgage should be at 5.5%, but instead it's
above 6%," said McBride. "The 30-year jumbo loan [a large mortgage
that is not federally guaranteed] is a full two percentage points
higher than it should be."
So for long-term fixed mortgage rates to go down, the Fed must
successfully make banks more willing to lend again.
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