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What Affects Interest Rates?

The Federal Reserve
If the Chairman of the Federal Reserve decides to lower the interest rates, does that mean that the interest rate on mortgage will also go lower? You would think so but in fact, there a a few reasons how that would cause the mortgage rates to rise.

Short vs. Long Term Borrowing
When the Federal Reserve lowers the interest rate, what they are actually doing is lowering the "Federal Fund rate". This is the rate that is set by the Federal Government which controls at what cost large banks will lend funds to each other. These are also considered short-term loans. Mortgages, however, are long term loans and long-term interest rates apply. Long-term interest rates are sensitive and fluctuate according to expectations of inflation. Therefore, if short-term rates are lowered as it happens when the Federal Reserve lowers the Federal Fund Rate, spending and borrowing will usually increase and may cause inflation to rise. If inflation rises, long-term rates such as mortgages may also rise as well.

The Stock Market
Markets and their investors are many times one step ahead of the Federal Reserve when in comes to speculation as well as action In a public stock market, interest rates are re-evaluated every single day. If the market believes that the economy is slowing down, the market may lower interest rates in anticipation the the Federal Reserve may lower its short-term rate. This has happened before as it did in the latter half of 2000 where we experienced a steady decrease of interest rates all the while the Federal Reserve left their short-term rate unchanged. In addition, the opposite effect can happen as martgage interest rates rise well before the Federal Reserve raises their short-term rate.

Impossible to Predict?
One may only hope to predict the future of something as complicated as the US economy. It is, however, very important for the mortgage shopper to understand some of the dynamics involved in the mortgage market. Not understanding these dynamics can result in costing you alot of money.

Article written by SAM
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