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With The Federal Reserve Holding Steady On Interest Rates, Is Now The Time To Buy?

Last week, Ben Bernanke and the folks at the Federal Reserve say they have no plans to raise interest rates until 2014. That means you’ve got at least two years to take advantage of the government’s ultra-low 0.25 percent rate on its Federal Funds.

Sounds like a great time to buy a new home, or take advantage of the low interest rates to refinance your current residence, right?

Well, not exactly.

While it’s tempting to draw a parallel between the interest rate on Federal Funds and mortgage loans, the correlation is shaky at best. It’s true that the Federal Funds rate and the Prime rate compare favorably; there’s also a relationship between the Fed’s rate and short-term loan rates, like a one-year adjustable rate mortgage, or ARM. But just because the Fed’s interest rate is expected to hold steady at that quarter of a percent rate for the next several years doesn’t mean mortgage rates will also stay at or near the historical lows we’ve seen over the past year.

The reason is complex. The most popular type of home loan on the market is the 30-year fixed loan, which has an interest rate that has bottomed out under four percent in recent months. However, even though the length of the term is 30 years, that doesn’t mean homeowners are holding on to their properties for the entire period. In fact, the average 30-year fixed loan is held for just seven years!

It’s because of this relatively short-term lifespan on a long-term loan that loan underwriters determine rates based not on the Fed’s interest rate – which, despite the Fed’s promise to hold the current rate steady for the next 24 months, typically fluctuates multiples times a year – but on five- and ten-year Treasury Constant Maturity bonds, also known as T-bonds. In fact, a comparison of T-bond and 30-year fixed loan rates over the past two years shows when T-bond rates dip, a drop in mortgage rates soon follows. Because T-bonds are less susceptible to the ebbs and flows of today’s turbulent market, the mortgage rates they influence are also largely protected from day to day changes.

Another key element that affects the mortgage market is inflation. Inflation plays a role in your mortgage application because it essentially acts as a financial vampire, stripping the loan’s value in the eyes of investors. For example, if you get a mortgage at a four percent interest rate – in the midst of two percent inflation – the total profit for the investor is two percent instead of the original four. That means when inflation goes down, you’re likely to see a drop in mortgage rates, since investors now have a wider profit margin; likewise, a rise in inflation also leads to a rise in mortgage rates.

Of course, there are other factors at play in the mortgage application process: the delays – ranging from a few hours to a few days – in securing an interest rate, your credit score, the size and length of the loan for which you’re applying, and market issues like supply and demand.

But the bottom line is this: while a low interest rate on Federal Funds is a good thing for a recovering economy, it’s not necessarily a good thing if you’re in the hunt for a new mortgage.



  1. I am doubtful that mortgage rates can go too much lower than what they have been the last few months. In other times, I’ve seen where things were in place that should have led to declining rates, yet they ended up going up. So, you never know!

  2. I’m going to disagree with “a low interest rate on Federal Funds is a good thing for a recovering economy”

    While it is possible that this is true, to state it so simply to suggest it is obviously true is very misleading.

    The federal government artificially holding interest rates low is, in my opinion, a terrible thing for a struggling economy. It tricks businesses into thinking they should be investing in building their company because low interest rates should mean that lots of people have money saved up to spend on their products. But these are fake low interest rates. People don’t have money saved up to spend on things, so businesses are investing under a false pretense.

    On the other hand, artificially low interest rates discourage savings for the consumer. So even though there are so many Americans living paycheck to paycheck with zero savings, the government has removed the incentive to save. So people will continue spending their way into oblivion.

    I would really like to see you back up that claim with more than just the “it’s obvious” implication you made.

    • @Kevin @, People also say that injecting money into the economy is a good thing, while others say it’s fake and changes numbers without having a long-term effect.

      In that case, there’s no question that when people have more money, they spend more money, so economic stimuli do help in the short-run. Cutting jobs is not a short-term fix, either, because it means people have less income to spend.

      Similarly, low interest rates get people to spend more in the short-term, which helps the economy in the short-term.

      I think this is a perfect example of personal finances and the economy not matching up. With the economy, everything is healthy when people are spending money. But individually, we’ll be in a better position if we save money than spend it. So the government isn’t doing what’s in our individual best interests, rather what it’s on our collective best interest.

      • @Daniel, Your response relies on my acceptance of the Keynesian theory that spending is the only thing that matters in a healthy economy. And sorry, but I don’t accept that notion.

        A healthy economy would have natural ebbs and flows as the economy shifts from a saving-oriented economy (high interest rates) to a spending-oriented economy (low interest rates). In a natural healthy economy, you can’t have the spending without the saving first.

        In your Keynesian view, we should always be in spending mode. You’re smart enough to realize that a perpetual state of spending is not sustainable; we need the saving to have the spending. This is where you and I differ.

        I suggest we allow the natural ebbs and flows of the economy. You suggest that to ensure we perpetually stay in spending mode, the Fed should print money and debase the value of our currency (which is essentially an tax that hurts the low and middle classes most).

        • @Kevin @, when people are hurting, it’s difficult to say ‘hey this is for the best, even if there’s high unemployment now, you’ll thank me later.’ If I were poor, I’d much rather have money upfront in the way of stimulus than have someone assure me that I don’t have a job now, but it’s for the best in the long-run.

  3. When Ben Bernanke announced the fed funds rate would stay below 1% through 2014, I told one of my friends that she really needs to get serious about refinancing the mortgages of the real estate properties she owns.

    Mortgage rates may not fluctuate in lock step with the fed funds rate but they are correlated. So, if you were afraid you’ll miss the window to take advantage of low rates, it sounds like there’s hope for you yet. If your credit score has been costing you an ungodly sum of money on interest, now’s the time to get serious about finding out what actions you should take to improve your credit and then do them.

  4. I really think that the interest rates are as low as they need to be or rather they are going to get. The problem is that a lot of people buy homes they cant afford in the first place. I would say if you cant afford it, its not really going to matter whether are not the rate is 5 or 3.25.

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