Fed moves will hit mortgage borrowers

We are now one year into the Federal Open Market Committee's campaign of raising short-term interest rates, and there have been some surprises along the way. The housing market is still humming along. The average 30-year fixed-rate mortgage has dropped from 6.3 percent to 5.66 percent. And Alan Greenspan has referred to the decline in long-term interest rates as being "without recent precedent."

Much has been made of this defiant -- and unexpected -- decline in long-term interest rates as short-term interest rates have climbed in the past year. Low fixed mortgage rates have fueled continued gains in home prices and strong volume in both home sales and mortgage lending. There has been no better illustration of the fact that the Fed's movements on short-term interest rates have no direct effect on fixed mortgage rates.

But this is a far cry from saying that the Fed has no influence on mortgage rates and the housing market. After all, the short-term indexes that are most responsive to Fed actions also serve as the benchmarks for repricing many adjustable-rate and interest-only loans.

Although the movement in fixed mortgage rates, which remain near historic lows, has been surprising, the cumulative effect of repeated interest rate increases carries significant relevance to the many homeowners with adjustable rate or interest-only loans.

Here is a glimpse at the movement in some major borrowing indexes over the past year.

The index that stands out as the exception is the 10-year Treasury note, which serves as the benchmark for fixed-rate mortgages.

The remaining indexes that commonly serve as benchmarks for adjustable-rate loans have moved like a school of fish in one direction -- higher. And this means that eventually, the payments on those loans will also move higher.

This is not confined just to borrowers with adjustable-rate or interest-only mortgages.

In lieu of a sufficient down payment, many home buyers have combined these adjustable or interest-only mortgages with a home equity line of credit. HELOCs have also been a popular choice for homeowners that are consolidating debt or making big-ticket purchases. But the Fed's influence has been felt here throughout the past year. HELOCs are commonly pegged to the prime rate, which increases in concert with Fed interest rate hikes, as seen in the chart above.

In the past year, the average HELOC rate has jumped from 4.77 percent to 6.24 percent, with some borrowers seeing even larger increases as the prime rate jumped from 4 percent to 6 percent in that time. The promise of another rate hike June 30, and the likelihood of more afterward, mean HELOC borrowers will see rates trending higher in the second half of 2005 at much the same pace as in the first half of the year.

Concerns about deflating real estate values revolve around the prospect of millions of borrowers facing sharply higher payments in the future. Regardless of the drop in fixed mortgage rates, many adjustable-rate and interest-only borrowers are on just such a collision course. With eight, going on nine, interest rate increases in the past year, and more yet to come, the Fed may have an influence on mortgage rates and the housing market after all.