Real Estate Finance Alerts

When Will Rates Bottom?
While I cannot tell you exactly when rates will bottom, I can highlight two common misconceptions about interest rates that will put you in a better position to make an informed decision when locking the interest rate for your loan.

The first misconception is that mortgage interest rates will go down 0.25% because the FED just cut the FED Funds Rate by 0.25 point.  I often have clients call the day of a FED Rate cut wanting to lock because they think rates are 0.25 lower than they were the day before.  The second misconception is that if the FED will cut the FED Funds rate in the future, rates will go lower.  Again, clients often tell me they are going to wait to lock their loan because interest rates will go lower when the FED cuts.  While rates may go down in both of these situations, borrowers who do not understand the real cause and effect and often make poor decisions as a result.  It is similar to thinking if it is not hot outside, I will not get sunburn.  Ambient air temperature has no correlation to radiation and sunburns.  Accurate information about interest rates is essential to making good rate lock decisions.

Mortgage rates are determined by the market for mortgage backed securities while the FED Funds Rate is the rate at which banks lend to each other.  It is true that mortgage rates are impacted by the FED Funds Rate, but the two are completely different, do not move in lock-step with one another, and often move in the opposite direction.  So if the FED cuts rates by 0.25 point, interest rates may or may not go down.  The reason why is because interest rates are based on future expectations and change when those expectations change.  For example, if the FED cuts the FED Funds Rate by 0.25 point, but the market is expecting the FED to cut by 0.50 point, rates will rise in the short run because the FED did not meet the market's expectations.  Similarly, in the scenario above, even if the FED cut by 0.50 point, rates would rise if the FED provided information that they are less likely to cut in the future.  Both scenarios result in a change to the market’s expectations of what the FED will do in the future.  Conversely, if the market is expecting the FED to cut over the next 6 moths by 1.00 point, not cut for the next 6 months, and then begin raising rates, as long as the FED acts as expected and they do nothing to change those expectations, rates will not go lower because the future expectations have not changed and the market already accounted for these actions.

When considering FED actions and their effect on interest rates, you must remember the cause and effect for interest rate changes.  The market accounts for current expectations of future actions.  Therefore, rates will change when those expectations change.  While this should not be considered a complete analysis of interest rates, it does detail the relationship between the FED's actions and interest rates.  With this understanding, you will make better and more confident decisions regarding your financing.