With the Fed decreasing the lending rates, will the interest rates on mortgages decline as well? This is an important question and one that many people are now asking. The answer unfortunately is that mortgage interest rates typically do not decline as the Fed funds and Fed discount rates are decreased. The Fed funds and Fed discount rates are short term rates and affect other short term rates. Mortgages, on the other hand, are long term instruments, and are therefore less affected by short term rates.
As a matter of fact, history has shown that when the Fed cuts rates (the Fed funds & Discount rates) mortgage rates can go up – not down. Back in 1998, mortgage rates were around 6.5% and the Fed cut rates 3 times. In response to this mortgage rates went up over 2% the following year. In the first part of the year 2000, after 6 rate increases by the Fed, mortgage rates declined from 9% to 6.75% during that year. In 2001, the Fed cut rates 11 times yet mortgages remained higher. Confusing? Well, sort of, let me explain.
While people think the rate increases or decrease by the Fed should move mortgage rates, the stock market and bond market have a greater impact. How come? Well, when the Fed changes rates it may lead to a stock market rally or decline. When this happens, the bond market usually reacts in an opposite direction to the stock market. So, if the stock market rallies because the Fed decreased rates, the bond market will typically decline and vice versa.
It’s helpful to know that as bond prices increase the interest rate on bonds will decline – it is an inverse relationship. So, if the Fed decreases rates and this, in turn, causes a stock market rally, bond prices will decrease and the interest rates on these bonds will increase, having a negative effect upon mortgage rates because mortages are long-term debt instruments just like bonds and act the same way. This is the classical and fundamental relationship and explanation of bond prices and interest rates.
Nevertheless, there can be pressure for mortgage rates to decrease even when the Fed decrease rates, which seems to contradict what I said above. This can happen in times where there is broad-based weakness in the economy and there is very little mortgage lending activity going on. In times like this, to spur mortgage lending, rates can decline. We are currently in such a time, so you may see mortgage rates actually decline - temporarily.
As a matter of fact, history has shown that when the Fed cuts rates (the Fed funds & Discount rates) mortgage rates can go up – not down. Back in 1998, mortgage rates were around 6.5% and the Fed cut rates 3 times. In response to this mortgage rates went up over 2% the following year. In the first part of the year 2000, after 6 rate increases by the Fed, mortgage rates declined from 9% to 6.75% during that year. In 2001, the Fed cut rates 11 times yet mortgages remained higher. Confusing? Well, sort of, let me explain.
While people think the rate increases or decrease by the Fed should move mortgage rates, the stock market and bond market have a greater impact. How come? Well, when the Fed changes rates it may lead to a stock market rally or decline. When this happens, the bond market usually reacts in an opposite direction to the stock market. So, if the stock market rallies because the Fed decreased rates, the bond market will typically decline and vice versa.
It’s helpful to know that as bond prices increase the interest rate on bonds will decline – it is an inverse relationship. So, if the Fed decreases rates and this, in turn, causes a stock market rally, bond prices will decrease and the interest rates on these bonds will increase, having a negative effect upon mortgage rates because mortages are long-term debt instruments just like bonds and act the same way. This is the classical and fundamental relationship and explanation of bond prices and interest rates.
Nevertheless, there can be pressure for mortgage rates to decrease even when the Fed decrease rates, which seems to contradict what I said above. This can happen in times where there is broad-based weakness in the economy and there is very little mortgage lending activity going on. In times like this, to spur mortgage lending, rates can decline. We are currently in such a time, so you may see mortgage rates actually decline - temporarily.
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