I speak to clients about mortgage rates, and many assume the long term interest rates are directly affected when the Fed drops in interest rates. In fact, mortgage rates actually increased slightly immediately after the last two rate cuts. So, what does affect mortgage rates?
The Fed sets the federal funds rate, and this is the rate that banks charge each other for overnight loans. Banks needs to balance their balance sheets. If the bank needs funds, they will borrow money. If they have a surplus, they will lend at the federal funds rate. The federal funds rate does not directly affect mortgage rates, but does affect a lender’s borrowing costs. Lenders are able to pay less for funding loans when the federal funds rate drops.
Interest rate changes for the 10 year treasury note will usually have a similar impact on 30 year mortgage rates. Inflation plays a key role in determining the 10 year treasury note. Mortgage rates are usually set 1 ½ percentage points higher than the 10 year treasury yield. This can be referred to as a risk premium. Because of the mortgage crisis, this risk premium spread has increased due to higher mortgage delinquencies and defaults. Hence, mortgage rates have not dropped as much as expected. Over time, the risk premiums should decrease. However, the yield of 10 year treasury notes will most likely increase in the near future.
Overall, interest rates are still very low. 30 year rates are in the 5.875%-6.00% range. Most 100% conventional loan programs are no longer available, because mortgage insurance companies are no longer offering mortgage insurance for 100% loans. Lenders require borrowers to have mortgage insurance if they put less than 20% down. If they cannot obtain mortgage insurance, the lender will not approve the loan.
Article written by our Broker, Chris Warren, Smart Source Realty