When the Fed Raises Its Interest Rate, Do Mortgage Rates Increase?

When the Federal Reserve raised the Fed Funds rate by a quarter percent last week, several media outlets (you know, the Fake News guys) reported that this would result in higher mortgage interest rates. However, mortgage rates fell the next day.  Isn’t there a connection?  Not really.

Let me first say that I am not an economist, or even close to it. The last time I studied economics was as a sophomore in college, and that was only the introductory course. And since I’m not in the mortgage industry, I only know what my mortgage partners have taught me — and one thing they have taught me is that the Fed Funds rate, which is the rate banks are charged for overnight lending, has no direct impact on mortgage interest rates.

 

I can certainly understand why the average American home buyer and the media, untrained in business economics, might think an increase in the Fed’s interest rate might apply to mortgage loans, but it doesn’t.

 

Here’s what I have learned, both from my mortgage partners over the years and, frankly, by Googling “What affects mortgage rates?”  (Try that yourself if you want to delve deeper into this subject.)

 

Mortgage rates are influenced by such factors as inflation, the market for bonds, and consumer confidence. It is also affected by financial instability overseas which can cause money to flow into America. 

Banks compete for your business (of course), so it only makes sense that what they charge for their product — money — is subject to the laws of supply and demand.

By that reasoning, if the economy is healthy and businesses are borrowing a lot of money, then banks can charge more for it, and that impacts what they charge for all kinds of borrowing, including for a home purchase.

Inflation has a direct impact on interest rates, and since any increase in the Fed Funds rate is designed to slow inflation, it actually helps to keep interest rates low, not increase them.

If the Trump administration follows through on its promised investment in infrastructure spending, that could spur the economy, which could put upward pressure on interest rates.  And if there are massive tax cuts, the government may have to borrow more money to keep operating, which can also cause mortgage interest rates to rise.

Another influence on mortgage interest rates not obvious to the general public has to do with the Fed’s ongoing purchase of mortgage-backed securities (MBS), in a policy known as “quantitative easing.” The government holds about $1.7 trillion of these securities and only buys new ones to the extent that existing loans are paid off.

My understanding is that the Fed’s purchase of such securities keeps mortgage interest rates low, and that if rising rates cause fewer homeowners to refinance — that is, to pay off their current mortgages — then there will be less purchasing by the Fed of new mortgage-backed securities, which then further feeds a rise in mortgage rates.

 

The “bottom line” is that the market rate for mortgages may adjust upwards in 2017, but not in step with, or related to, any increase in the Fed Funds rate.

 

For buyers, the more worthwhile discussion to have would be about the type of mortgage you apply for, and how you might improve the one key factor in the interest rate you pay — your credit score.   

I’ve written about this before. Read my Feb. 23, 2017, Denver Post column, which is archived at www.JimSmithColumns.com.

 

Too many buyers (and their mortgage brokers) gravitate to 30-year fixed loans, but those are the most expensive loans. If you can afford a larger mortgage payment each month, a 15-year fixed rate loan carries a much lower interest rate and will save you tens of thousands of dollars in interest over the life of the loan. If you must amortize your mortgage over 30 years, but don’t expect to keep your home for 10 or more years, then consider an adjustable rate mortgage (“ARM”), which will be fixed at a lower rate for 5, 7 or even 10 years before adjusting upward. Your savings during that initial term can be big enough that a 5-year ARM might save you money versus the cost of a 30-year fixed rate loan, even if you keep it for 6 or 7 years.

 

I’m guilty of making that mistake myself. For as long as I have owned homes (that’s since 1982), I’ve never owned a house more than seven years, yet all of my homes were financed with fixed-rate 30-year loans. I could have saved a lot by getting an ARM each time.

Published March 23, 2017, in the Denver Post's YourHub section and in four Jefferson County weekly newspapers.

15-Year Fixed Rate Mortgage Hits New All-Time Record Low

[From Realty Times this morning]

In Freddie Mac's results of its Primary Mortgage Market Survey®, average fixed mortgage rates declined for the third consecutive week on the heels of a weaker than expected employment report. The 30-year fixed averaged just above its record low while the 15-year fixed averaged a new all-time record low of 3.11 percent breaking its previous low of 3.13 percent on March 8, 2012.
Full Story: http://realtytimes.com/rtpages/20120413_freddierate.htm

Home Buyers Can Save by Purchasing Before FHA Fees Go Up on April 1st

[Published March 1, 2012, in the Denver Post]

      A quick check of Metrolist, the Denver MLS, shows that about 30% of homes purchased for $400,000 or less are financed with an FHA-insured loan. These loans are popular because they require only a 3.5% down payment.

      FHA interest rates are comparable to those for conventional loans, but extra fees are charged, both upfront and monthly, for mortgage insurance premium (MIP). These fees replenish FHA’s reserves, which have been depleted by the high number of foreclosures on FHA-insured loans in recent years.

      There is a 75% increase in the upfront fee for those FHA loans initiated after April 1, 2012. This upfront payment, which is currently 1% of the loan amount (and can simply be added to the principal), increases to 1.75%. Thus, on a $300,000 loan, this added principal amount is currently $3,000, but will increase to $5,250 on an FHA loan initiated in April, adding about $11 to the monthly mortgage payment in the above example (based on a 4% interest rate).

    Currently, the monthly mortgage insurance premium is 1.15% annually (1.1% when the down payment is 5% or more), and this fee increases by 0.1% to 1.25% and 1.2% respectively.  Thus, on the same $300,000 loan, the monthly MIP payment is currently $287.50 (assuming 3.5% down payment), but goes up to $312.50, an increase of $25 per month.

That $25 increase, unlike the $287.50, does not go to the FHA. Instead it goes to the Social Security Trust Fund. As noted in my Jan. 12th column, this increase is mandated by the Temporary Payroll Tax Cut Continuation Act of 2011, which was passed in December. That act reduced the Social Security tax for just two months, but is charged to new borrowers for the next 10 years. Doesn’t seem fair, does it? 

On their website, HUD calculates that the average FHA borrower will pay only $5 more each month for that additional mortgage insurance premium, but I don’t see how they could come up with such a low estimate.

The monthly MIP must be paid for 5 years, regardless of the percentage down payment, but can be removed once the homeowner can document 20% or more equity.

Current FHA loans, and loans initiated before April 1, 2012, are not subject to these higher fees.

Conventional loans are also affected by an increase comparable to that $25 per month, but it will be reflected in the loan’s interest rate instead of appearing as an additional fee. 

Mortgage Cost Increase to Pay for 2-Month Extension of Payroll Tax ‘Holiday’

[Published in the Denver Post on Jan. 12, 2012]

It was big news in December that the House Republicans caved in and agreed to extend the federal payroll tax “holiday” for two months, as agreed by Senate Republicans.

But what didn’t make the news was where the money would come from to pay for that tax reduction.  It’s going to come out of the pockets of homebuyers in the form of increased loan costs.

I was first made aware of this by a Jan. 5 email from a respected mortgage consultant. I confirmed it this past Sunday in a conversation with Rep. Ed Perlmutter in Golden.

The mortgage consultant wrote: “For conforming products, it has been determined that something known as a Guaranty Fee that all lenders pay to the Government Sponsored Entities [Fannie Mae & Freddie Mac] will increase by 10 basis points in yield. Effectively, that means all conforming loans will increase almost .125% in rate. [Fannie and Freddie] are requiring this increase for loans delivered to them beginning in the second quarter of 2012. You will see the increase effective on Wednesday, Jan. 11, 2012. In some cases, the actual rate impact will be as little as 27 basis points. In other cases, the impact will be as high as 77 basis points. And the impacts will vary day-to-day, depending on the rates and the market’s attitude.” (A basis point = 1/100th of 1%.)  

FHA loan costs will go up by an equivalent amount.

According to Rep. Perlmutter, you can thank the Republicans for this development.  The Democrats wanted to pay for it with a tax on those earning over $1 million per year, but the Republicans would not allow it and, to honor their no-tax-increase pledge, came up with this non-tax approach to providing the required offsetting revenue. According to the email I received, it will take 10 years for this mortgage cost increase to offset that two-month payroll tax reduction.

I’m amazed that Republican leaders continue to think they can attract votes from the general population by doing whatever it takes to keep taxes low for the top 1% of the population.  I suspect they are only providing ammunition that will cost them in the 2012 elections.

I lived in Washington, DC, when I was a reporter for the Washington Post in 1968. I’m keenly aware that the 550,000 residents (mostly Democrats) of our nation’s capital do not have voting representation in Congress.  DC’s license plates declare “Taxation Without Representation.”  Wasn’t that the rallying cry at the Boston Tea Party?   Why isn’t today’s Tea Party working to right that injustice?

Yes, You CAN Buy a Home With Less Than a 20% Down Payment!

[Published on Jan. 5, 2012, in the Denver Post]

One of the most prevalent misconceptions among home buyers is that you need a 20% down payment to get a mortgage. In fact, the majority of loans being written today are FHA-insured loans requiring only 3.5% down payment.  The VA still offers 100% financing to qualified veterans, and one can buy a home with only $1,000 down through the Colorado Housing and Finance Authority.

Another misconception is that mortgages are less available. That, however, is only true if the borrower has a credit score under 620.  That’s the big change from the “bad old days” of toxic loans — banks now make you prove that you can pay back the loan. Underwriters require so much documentation to prove you’re qualified that I’m glad I’m a Realtor, not a mortgage broker!

The FHA loan limit in our area is currently $406,250. You can buy a home for more than that amount, but that’s all the FHA will allow you to borrow.  Although FHA loans are most typically used by the middle or lower middle income buyer, there is no income limitation to qualify for an FHA loan.  FHA loans also carry no pre-payment penalties, and, best of all, they are assumable by qualified buyers.

The assumability of FHA loans is especially valuable now that a buyer can obtain an FHA loan for about 3.75%, which is below the rate on a non-assumable conventional loan.  When you sell your home 5, 10, or 20 years from now when rates are much higher, wouldn’t it be great to advertise that you have an “assumable 3.75% loan”?

FHA also offers 3-, 5-, 7- and 10-year Adjustable Rate Mortgages. ARMs are currently being offered at rates under 3%, which is incredible!  As someone who tends to move every five years or so, I’d jump at a 5-year ARM. Even with a maximum adjustment in years 6 and 7, it would take at least that long for a buyer to pay more than he would over the same period on a 30-year fixed-rate loan.

If everyone knew that they could buy a home with as little as $1,000 down payment — or, at worst, 3.5% — we would see a lot more buyers than we do in the market taking advantage of these incredibly low interest rates.  And, indeed, there are already enough buyers in the market now to deem it “hot.”  My end-of-year index [posted on this blog on Jan. 1st] shows that 26.8% of Front Range MLS listings are under contract. In Jeffco (minus foothills areas), 32.3% of the inventory is under contract.  In Denver it is 34.2% and in Aurora it’s 48.9%.  Now, that is what I call a hot market!