Federal Rates vs. Mortgage Rates

After the Federal Reserve Board lowered  the federal funds rate by the 50 basis points on October 29, 2008, we received a lot of calls asking:  ” Why mortgage rates are not going down?”  Mortgage rates are not closely connected to the federal funds rate. In fact, this year the federal rates were moving down, the mortgage rates were moving in an opposite direction, up.

So back to the basic. There are 3 major types of federal rates:
1)  The federal funds rate is the rate at which banks lend money (federal funds) to each other for overnight loans made to fulfill reserve funding requirements. The federal funds rate was cut from 1.5% to 1.0%. The Federal Reserve has responded to potential slow-down by lowering the federal rate during recessions to regulate the supply of money in the US economy. Change in the federal funds rate can have the wide impact on the value of the dollar and the amount of lending. 
2) The discount rate is an instrument of monetary policy (usually controlled by central banks) that allows eligible depository institutions (such as a savings bank)  to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity. An example of a non-depository institution might be a mortgage bank. The discount rate is usually higher than the federal funds rate.
3)  The prime rate, or Prime Lending Rate, is a term applied to a reference interest rate used by banks. The term originally indicated the interest rate at which banks lend to favored customers. Some variable interest rates may be expressed as a percentage above or below prime rate. It is currently 4.00% in the United States. Prime rate is used often as an index in calculating rate changes to adjustable rate mortgages such as HELOC (home equity line) and other variable rate short term loans.

It is a common confusion to tie the federal discount and prime rates to the mortgage rates. A mortgage is a loan where the interest rate on the note and the rate adjustments are imposed by lenders. We offer you to look at the mortgage rates the following way:  the lenders charge higher interest rates for high risk loans. Believe it or not,  Real Estate today is considered a high risk investment due to a low demand for RE, falling RE prices, strict mortgage lending guidelines, the credit crunch.  The lenders treat the adjustable rate mortgages and the fixed rate mortgages differently. Adjustable rate mortgages are tied to an index on the short and middle term government securities. Fixed rate mortgages are tied to the long term securities. Usually, fixed rate mortgages are higher than adjustable rate mortgages.

Compare 2008 mortgage rate trends.

 

 

Advertised Mortgage Rate vs. Your Actual Rate

When you shop for the mortgage interest rate, you usually ask for a rate quote and get immediate answer from a broker. Don’t make a mistake! It ’s not the rate you will get. Banks and mortgage brokers might quote you a Par Rate.  Par Rate is the lowest rate before rate adjustments for a mortgage program you need. Your Actual Rate most likely will be higher than quoted for the following reasons:
     -Rates are subject to change every day, and even within the day, so the rate quoted,  reflects the market only at that point in time. It’s like the stock market - hard to predict it will go up or down.  You are guaranteed with the rate only at the time you lock.
     -Adjustments! Different lenders have different par rates and impose different adjustments. Don’t trust advertised rates, look for an honest and professional broker who will research the market for the best rate for you. First, a broker must collect information about you (employment, income, assets, debt, credit report with credit scores, etc.), analyze your situation, do math, understand your aims. Second, a broker will run your scenario with different banks trying to find lenders that are willing to accept your application, especially on today’s market, and choose the best lenders for you. Only then, he will discuss with you available mortgage options and provide the actual rate quote. Finally, after you make a decision, a broker will submit your application and either lock the rate or will wait for the better market conditions (both only with your permission). 

Your Actual Rate = A Par Rate (at the time it was locked) + Rate Adjustments

For example: You want to refinance owner occupied single family residence. Your house market value (appraisal) is 800K and the new loan amount is 720K (90% Loan-to-Value). Your middle credit score is 700 and you have full documentation (full income/full assets).

What rate adjustments can you expect?
-State adjustment – Lenders might provide different rates for different States.
-Credit Score adjustment – Your middle credit score is less than 740. Usually, each 10-20 points lower might increase your rate.
-Cash-out refinance adjustment – Assuming you want to get some cash from your property or to consolidate your debt.  Your rate will be adjusted to a higher rate vs. rate and term transaction.
-High Loan-to-Value adjustment- Your property has 90% LTV. Usually beginning from 70% LTV, each 5-10 points higher will increase adjustment.
-Jumbo Loan adjustment – For the higher loan amount your rate will be higher.
Some Lenders will not impose adjustment for cash-out transactions, or higher Loan-to-Value ratio, or jumbo loans. We work with them.
-Closing Cost adjustment – The less closing cost you would like to pay the higher rate might be. Check our  post Closing Cost vs. No Closing Cost.
-Lock adjustment – The longer period of lock, the higher interest rate.

 As a rule of thumb, the Lenders adjust your rate higher if the property is an investment property, second home, two-four family residence or coop.
 

Here you can check the current conforming par rates for the most popular programs.

Mortgage Industry During Financial Crisis

The current global financial crisis, credit meltdown, housing crisis — the worst economic situation that our country is facing since the great depression.  Most people do not understand exactly what happened and what’s going on. Everyone seems to be blaming someone – Wall Street, the government, banks…. Should we point a finger at ourselves also? Absolutely! And this is your responsibility to choose the right broker and understand the mortgage program you agree to take. People spend more time picking the color of new washing machine than on one of the most important financial decisions such as a real-estate investment.
Most people have no idea or a vague idea of how the mortgage industry works.  Knowledge is a key to figure a way out of the mess.
The mortgage industry is very challenging and the market is constantly changing. Old rules don’t work anymore. Many mortgage programs were eliminated. Guidelines are changing almost everyday and became more strict and demanding.  Does it mean we can not obtain a mortgage? No. Banks are still lending. Despite common disbelieve the following programs still exist:  95% Loan-to-Value ratio, Interest Only refinance, 1 day off MLS refinance, no hit for cash-out refinance, no hit for Jumbo Loans up to 750K, no mortgage insurance on loans over 80% Loan-to-Value, 1st position HELOC up to 350K. Whether you are refinancing or ready to get into a new house, you must be aware of new rules and current mortgage options.

Our goal is to make sense of the uncertainty in today’s mortgage industry. We will provide you with mortgage news, current rates, new rules and guidelines. We will explain the requirements and how to prepare for refinance or purchase of a property, how to improve your credit history, how to get better rates and what is the fair amount of closing cost.  Our approach is to educate you about your largest financial transaction. We will share with you our knowledge, and we hope you will benefit from our blog.

YOUR SUCCESS IS OUR PROFESSIONAL PRIDE
Don’t hesitate to make your comments.  Good-luck to you.