What is going on with Mortgage Rates?
[ October 16, 2008 ]

I get a lot of questions from readers these days about mortgage interest rates. Without a doubt, the most frequent question involves how mortgage rates could be going up when the Fed is cutting rates.

Most people don’t understand how big a roll the financial markets play in the life of the everyday American. You hear a lot in the Presidential campaigns about how Wall Street’s woes are trickling down to Main Street. While that’s true, we all need to understand that the road between Wall Street and Main Street is a two way street. What effects one, affects the other.

There’s plenty of blame to spread around and lots of finger pointing is going back and forth, but the bottom line is that both sides have fed into our current economic state and it will take both sides to get our economy growing again.

So, how does all that affect interest rates?

Without getting too technical… let’s have a look at what goes into determining fixed and adjustable mortgage rates.

The simple difference is that Fixed mortgage rates are tied to Treasury Bond yields, while Adjustable rate mortgages are primarily indexed to the London Inter-Bank Overnight Rate (LIBOR.)

In the case of fixed rate mortgage loans, the Fed is pumping billions into the financial system to ease the credit crunch. To raise the money needed, they sell Treasury Bonds. Because Treasury securities are so readily available, Fannie Mae and Freddie Mac, the two largest US players in the mortgage backed securities market, have been forced to raise yields on mortgage backed securities to entice investors. In order for Fannie Mae and Freddie Mac to pay investors higher yields, they have to charge higher interest rates on mortgage loans.

In the case of adjustable rate mortgages, most are tied to the LIBOR rate. The LIBOR rate is the overnight rate at which international banks lend money to each other. With so many banks in danger and so many big banks literally facing bankruptcy, they are all afraid to lend to one another, and are charging higher than normal rates due to the increased risk. Since most adjustable rate mortgages are tied to LIBOR, those rates are remaining higher than they normally would be even though the Fed has substantially cut the Fed Funds Rate.

The bottom line is that mortgage rates should be lower. Unfortunately, fear and the high cost of worldwide financial rescue plans are pushing mortgage rates artificially higher. While nobody can predict exactly how long these factors will continue to artificially inflate market mortgage rates, we should see rates come down significantly as economic and financial fears subside and as the full affect of the worldwide economic rescue packages take full effect.

Until then, FHA loans remain the best option for the vast majority of Americans. Because FHA insures loans written by lenders, there is very little downside risk to the lender or to the investor who buys FHA mortgage backed securities. As a result, rates on FHA loan rates are much lower than for comparable conventional mortgage loans (direct bank loans.)

For additional information on FHA loans and how FHA mortgages can help you, click here


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