Today the Federal Reserve raised the Federal Funding rate by 0.25% — raising the short-term benchmark for the 17th time in a row and the second time in a row for new Fed Chief, Ben Bernanke. The Federal Funding rate now stands at 5.25%.
In the statement released by the Feds today, they left the door open for additional rate hikes, largely dependent on economic data released from now until their next policy meeting on August 8th.
Most consumers will hear the news that the “Feds have raised rates again” and think about the interest rate on their mortgage. Interestingly, the Federal Funding rate is the rate at which banks lend money to each other in order to meet their mandated reserve requirement. When the Feds raise this rate, it increases the cost of doing business for banks, and that additional cost is passed onto consumers in the form of higher interest rates on auto loans, consumer loans, business loans, credit cards and second mortgages. Most banks lend money in these categories based on a standard “prime rate” (generally 3% above the Federal Funds rate). So, tomorrow morning’s 2nd mortgage and home equity rates are likely to increase by 0.25% across the board.
So what about long-term mortgage rates?
Well, a rate-hike by the Feds is mostly good news for mortgages. A rate-hike by the Feds is a signal that the Feds are fighting inflation, and inflation is the arch-enemy of mortgage-backed-securities and mortgage bonds. If investors are overly concerned about future inflation, then their return on investment (for a long term mortgage loan, for example) will have to be more in order to compensate for the deterioration of value. It is actually the fear of inflation that helps to drive mortgage rates higher. Today’s move by the Feds (and even more so, their comments) are a good signal to the market that the Feds are committed to fighting inflation and ultimately protecting the value of long term investments. The comments from the Feds — confirming the recent “moderating of economic growth” and the fact that “inflation expectations remained contained” — were met by a late-day rally in the mortgage market, likely to result in an improvement in interest rates for tomorrow.
While the Fed’s actions aren’t likely to change the course of mortgage rates drastically, if you (or someone you love) are in the process of purchasing a home, tomorrow might be a great day to take advantage of locking-in your rate . . . and if you currently have an adjustable rate mortgage (especially one that is due for adjustment in the next 1 to 24 months), then you are well past-due to consider your options.
More on adjustable rate mortgages (ARMs) and interest only ARMs next time. A great tool to manage your cash-flow? or “exotic” and “dangerous”? (you laugh, but I read them described that way)