There’s been a lot of discussion about when the Federal Reserve will increase their rates, and the effect on mortgage rates. The correlation may not be what you think.
The Fed mainly implements monetary policy largely by adjusting two rates. The “federal funds rate”. This is the interest rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed.
Directly set the “discount rate”, which is the interest rate for “discount window lending”, overnight loans that member banks borrow directly from the Fed.
These are literally short term, overnight rates, and even though they can stimulate or slow down the economy, they don’t directly have anything to do with a 30 year mortgage rate.
Here’s a chart that can diagram several elements that can show you the interactions between interest rate vehicles. It goes from 2005 through 2015. And the interest rate from 0 to 8%. The vehicles shown are the Fed Fund rate, 5 yr CD, 10 yr treasury, Prime rate, and 30 yr fixed mortgage rate.
Here’s the story and the correlation between the rates. In 2005 & 2006 a combination of Greenspan and then Bernanke, as Federal Reserve Chairman increased the Fed rate to slow the economy and overheated real estate market. As far as a direct correlation you can see how the Fed Funds and Prime rate track directly, but not the other rates. As a generality the Prime is 3% above the Fed rate, so when the Fed changes their rate, automatically the Prime adjusts. The other rates are market driven, and the Fed has no direct control over them.
The 10 yr note and 30 yr fixed rate mortgage track directly. Even though the mortgage is a 30 year loan, the historic average life of a mortgage is around 7 ½ years, because borrowers refinance or sell the property. Investors of mortgage backed securities look for yields that correlate with the 10 US note rate, plus the additional margin taking into account the higher risk factors of the mortgage.
Here are some interesting areas to make note of. During the 2006 2008 timeframe there were areas of inverted yields. That’s where the short term rates were actually higher than the long term rates. You can see where at this point the over night fed rate was higher than the 5 yr CD and the 10 yr note. In fact in early 2008 the yield curve was absolutely flat with the Fed funds rate, 5 yr CD and 10 yr notes rates all at just under 4%.
The bottom line, the mortgage and longer term interest rates are market based and determined by the big money out there. International and domestic investors, pension, hedge, and mutual funds. You can see in the chart, even with Fed fund rate at 0 since 2009, there’s been plenty of long term rate volatility.
There are several reasons why I personally follow what the Fed does, but as you can see there is more at play when it comes to mortgage rates.
If you are in the Los Angeles area, have any questions or real estate sales or financing needs, feel free in contacting me.
Ron Henderson GRI, RECS, CIAS
Multi Real Estate Services, Inc.
Gov’t Affairs Chair – California Association of Mortgage Professionals
Specialist in the Art of Real Estate Sales and Finance
Real Estate market, mortgage rates, Los Angeles, San Fernando Valley, Conejo Valley, Simi Valley, Woodland Hills, West Hills, Calabasas, Chatsworth