Most people don’t know a whole lot about what the Federal Reserve Bank does, or how the decisions it makes at its meetings affect the cost of mortgages. The most basic explanation goes something like this: When the economy is good, the Fed raises rates to prevent overspending (which leads to inflation). This is called “tightening the money supply.” When it’s bad, it lowers rates to stimulate purchasing and investing. This is also called “loosening the money supply.”
Today’s financial reports are about as cheerful as the Chicago sports pages during baseball season. You’d expect the Fed to keep rates low, and you’d be right – that’s what it’s doing. On June 20, 2012, Fed officials released a statement, saying that poor economic figures "are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
Does that mean mortgage rates will stay low through 2014? Probably not.
Mortgage costs can go UP when the Fed lowers rates? Huh?
Reading the financial news, it's easy to think that if your mortgage rate goesdown, it's because the Fed "lowers" interest rates. That's simply not the way it works. Banks and other institutions are required to turn over a certain percentage of their deposits, called reserves, to the Federal Reserve Bank, which makes sure that there is money available to pay depositors when they want it. So when the Federal Reserve "changes" interest rates, it simply targets a different rate and uses its control over these reserves to change the supply of money – more money means lower short-term rates, and less money means higher short-term rates. The Fed can't dictate what banks charge customers, and its influence over short-term rates does not extend directly to mortgage rates. However, when the Fed publicizes its intent to stimulate the economy, bond investors may worry that the stimulus could cause inflation – this would push bond prices down and mortgage rates up. This potential problem is the reason many mortgage experts advise people to lock in their rates before Fed meetings.
Doing the twist: mortgage rate lowering program extended
One additional change that came out of the June 2012 meeting also can affect mortgage rates, so you should be aware of it. Since September 2011, the Fed has been pursuing a strategy of selling off Treasury securities with remaining maturities of three years or less, and buying equal amounts of securities with maturities of up to 30 years – the idea is to keep the prices of long-term debt, like mortgages, low. This program, dubbed Operation Twist, was slated to expire at the end of June 2012. The Fed decided to extend it through the end of 2012, and will sell $267 billion in shorter-term securities and replace them with longer-term bonds.
Does this mean mortgage rates will drop further? Many analysts think not – those who invest in mortgages are showing reluctance to buy loans with ultra-low rates because they can invest more profitably in other things. That’s putting upward pressure on mortgage costs, and the difference between the 10-year Treasury yield and Freddie Mac’s average 30-year fixed-rate mortgage rate has widened from about 1.3 percent in April 2012 to about two percent in late June. Many economists don’t believe that the Fed will be able to push mortgage rates any lower no matter what it does.
Reasons to pull the trigger on a mortgage
The last consideration for those on the fence about refinancing or buying a home is the speed with which things can change. Mortgage rates come down slowly as markets absorb financing news and loans are repriced. But when things go the other way, fears of inflation can cause rates to spike very quickly – too quickly to close on a refinance or even lock in a mortgage rate. By trying to go even lower than the record-setting mortgage rates available today, you do risk missing out altogether.