Mortgage rate analysis:
When shopping for the best mortgage rate, anticipation is key
By Michael D. Larson • Bankrate.com

When a good quarterback tries to hit a receiver deep in the opposing team's secondary, he doesn't throw the football where that receiver is at the time of the ball's release. He anticipates where that receiver will be by the time the ball makes its 40-yard journey and throws it there.

Unfortunately, most mortgage hunters don't realize they need to use the same game plan in order to get the best rates. They wait until the 6 o'clock news says something about the Federal Reserve Board cutting interest rates to call a lender and by then, the lowest loan rates can already be gone. Consumer quarterbacks who don't learn to anticipate the Fed, rather than react to it, may end up with the mortgage rate equivalent of a dropped pass at best -- or an interception at worst.

I've explained before why Fed rate cuts don't necessarily lower mortgage rates, as well as why they can actually send mortgage rates higher. But with all the new home buyers out there (and many homeowners who skipped class last time around now looking to refinance!), it bears repeating.

Know the playing field
For starters, that banker you talk to down the street when you're looking for a loan doesn't control the rate you're charged. Neither does some committee of cigar-chomping executives upstairs. Most banks, mortgage brokers and other lenders dump their loans into what's called the "secondary market."

To make a long story short, the secondary market is where Fannie Mae, Freddie Mac and other mortgage investors ply their trade. They purchase loans that lenders make, then either hold them in their portfolios or bundle them with other loans into mortgage-backed securities. Those securities get sold to mutual funds, Wall Street firms and other final investors who trade them the same way they trade Treasury securities and other bonds.

As a result of this business model, investors are in the driver's seat when it comes to setting mortgage rates. Whenever economic news suggests the economy is heating up too much, they demand higher yields from lenders. That's because they don't want to buy low-yield bonds now if Fed rate hikes (designed to cool the economy down) are going to make higher-yield bonds available later. The only way lenders can get their loans sold in this environment is to raise the yields they offer investors. This drives the rates they charge to consumers higher.

The same thing happens in reverse when it looks like the economy is degenerating. Investors start clamoring for bonds because they figure the Fed will have to cut rates in the future (to get the economy going again) and if they wait, they'll end up with lower-yielding bonds. Since investor demand is so strong, the lenders who control loan supply can offer lower yields. This results in lower rates for consumers.

So that's the mechanism by which your rates are set. But why does it matter?

Look ahead to hit your target
Remember that investors play the anticipation game. If a Fed cut is expected to get the economy back on track after a period of weakness, they figure the next step (no matter how far in the future) will be a Fed rate hike. After all, the economy will eventually get strong enough that the Fed will have to cool things off again. As the cutting cycle comes to an end, investors generally start demanding higher yields to compensate for the risk a hiking cycle will come next and mortgage rates will climb.

The process last played out in 1998 and 1999. In late 1998, the Fed cut rates three times to stave off the Asian economic flu. While the final two reductions didn't take place until Oct. 15 and Nov. 17, 30-year mortgage rates bottomed out on Oct. 7 at 6.46 percent, according to Bankrate.com historical data. That's because market watchers anticipated the Fed's work would soon be done.

Rates then remained in the 6.75 percent to 7.25 percent range through the first four and a half months of 1999 because no one expected any more Fed moves. But in late May and early June, they started shooting higher because disturbing economic and inflation news led investors to conclude Fed hikes were on their way. Sure enough, the Fed followed through with an increase on June 30.

The point isn't to make you panic. Rate cuts almost certainly won't give way to rate hikes any time soon. And even in the last low-rate cycle, rates stayed below 7 percent for four months before the October bottom in 1998 and most of the six months after. That gave borrowers plenty of time to refinance or lock in low even if they missed the absolute nadir.

But if you really want the best deal out there, you have to approach the game like a pro. Follow economic news. Visit Web sites that track economic developments in real time. Anticipate, rather than react to, the market. That's the only way you'll end up in the mortgage-shopping Super Bowl.