How the Fed’s rate decisions affect mortgage rates

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The Federal Reserve has been working overtime to keep the mortgage industry afloat and stabilize mortgage rates as it wades through deep waters generated by the coronavirus pandemic.

Chairman Jerome Powell has let loose the Fed’s arsenal of fiscal authority by issuing a blank check to buy Treasury and mortgage-backed securities. Within a month, between March 16 and April 16, the Fed was buying $79 billion of securities per day, expanding its portfolio to some $6 trillion. The purpose is to keep the mortgage industry liquid so that lending doesn’t dry up.

The Fed also issued an emergency rate cut on March 15, lowering the target Fed funds rate to 0 to .25 percent. The Fed kept the target rate steady at near zero at its Federal Open Market Committee (FOMC) meeting today.

Regardless, the fed funds rate does not have a direct impact on mortgage rates, which typically move in lockstep with 10-year Treasury yields. For now, the Fed’s primary influence on mortgage rates will be to maintain confidence in the market by supporting it with cash infusions.

“The Fed’s main job is to make sure the mortgage market continues to function. The Fed is going to stay the biggest buyer of mortgage-backed securities,” says Greg McBride, Bankrate’s chief financial analyst. “The extent of the buying will depend on the market, if the credit starts to tighten the Fed will inject more liquidity into the market.”

What Fed rate decisions mean for mortgage rates

The mortgage holders that benefited most are those with adjustable-rate mortgages or ARMs, as the Fed cuts meant reductions to their mortgage bill.

Variable rates usually move in the same direction as the federal funds rate. The federal funds rate, however, doesn’t directly affect long-term rates, which include financial products like 30-year fixed-rate mortgages; those tend to move with long-term Treasury yields.

Most variable and short-term rates are linked to two benchmark rates: the prime or the London interbank offered rate (Libor) plus a margin, which is a number of percentage points. These rates usually march in step with the federal funds rate, so rate cuts mean an extra jingle in some borrowers’ pockets.

Few economists expected another rate cut because that would mean negative rates, and that has implications that could create even more problems for economic policymakers to deal with down the road, when the pandemic subsides and the country gets back to work.

What ARM borrowers should know

Variable-rate loans, such as 3/1 and 5/1 ARMs, as well as home equity lines of credit, or HELOCs, get more or less expensive as the Fed boosts or lowers rates. This can be a boon for borrowers or a drain on their wallets, which makes variable-rate loans a sometimes-risky proposition.

Products like 5/1 ARMs give consumers the first five years with a fixed rate; after the fixed-rate period ends, there are annual rate adjustments for the remainder of the loan. So, if your rate drops during the adjustment period the cost of your ARM drops, too.

What homeowners should do

Would-be homebuyers interested in a fixed-rate mortgage or those who want to refinance should take advantage of today’s low interest rates, experts say. There’s no way to time the market to get the best deal on rates, says Kan.

The 10-year Treasury began the year at 1.78 percent, then nose-dived as the pandemic intensified, dropping to as low as 0.49 in March before settling at the current 0.64 percent. By any scenario that doesn’t include negative interest rates, there’s simply not much room for this key benchmark for mortgages to get much lower. That is, unless lenders start cutting the spread between the 30-year fixed mortgage rate and the Treasury rate. That spread has widened considerably as the economy has faltered.

The best course of action for homebuyers is to decide whether they can afford the home they want based on their down payment and current mortgage rates. Or how soon they can recoup the costs of a mortgage refinance. Today’s mortgage rates are low by historical standards, so waiting for even lower rates can mean missing an opportunity.

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