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.