Mortgage rates lower, too? Not so fast
By Holden Lewis • Bankrate.com

Yes, the Federal Reserve cut short-term rates. No, that doesn't mean that mortgage rates will inevitably go down, especially in the short term.

A look at mortgage rates must begin with a history lesson. From Jan. 3, 2001, to June 25, 2003, the Federal Reserve reduced its target for the federal funds rate 13 times. Here's what happened to the average 30-year mortgage rate in the month after each cut: It fell eight times and rose five times. It's simply not true that a Fed rate cut automatically leads to a drop in fixed mortgage rates.

Because this point is so widely misunderstood, mortgage people wax passionately about it. Such is the case for Dan Dowling, president of United Mortgage Capital Corp., in Altamonte Springs, Fla., who declares emphatically, "There is zero causation between mortgage rates and the Fed reducing its target for the federal funds rate."

Whenever the Fed cuts the federal funds rate, customers call mortgage lenders, eagerly expecting to take advantage of a drop in mortgage rates. By the time these phone calls are over, customers frequently feel disappointed and even suspicious. It just doesn't seem right. Why would banks raise mortgage rates while the Fed is cutting rates?

Things aren't that simple (or that sinister). Mortgage rates go up and down according to investors' expectations of long-term inflation. Simply put: If investors think inflation will accelerate, mortgage rates (and other long-term interest rates) rise.

The nation's overall economy doesn't appear to be in recession (although the housing sector, and some Midwestern states, might be). Yet the Fed added some stimulus by cutting the federal funds rate. That, in turn, could lead to faster-rising prices and, therefore, higher long-term interest rates.

What mortgage rates portend
Mortgage rates often anticipate Fed rate moves instead of reacting to them. Just two months ago, in mid-July, the average rate on a 30-year, fixed-rate mortgage in Bankrate.com's weekly survey was 6.82 percent. This week, it was 6.32 percent -- exactly half a percentage point lower. And the Fed just reduced the federal funds rate by the same margin of half a percentage point.

Dowling says that when you see mortgage rates declining, they're reacting to market forces -- and the Fed eventually plays catch-up. "The Fed didn't cause the decline (in mortgage rates), which already took place prior to them lowering the rate," he says.

Bob Walters, chief economist for Quicken Loans, agrees that fixed-rate mortgages "priced a lot of this move in." He expects long-term mortgage rates to remain stable, unless the overall economy stumbles. Starting rates on adjustable-rate mortgages will drop, Walters says, because they're more sensitive to Fed rate moves.