Will the Fed keep mortgage rates low? If so, how?

August 03rd, 2010

Mortgage rates for conventional and FHA mortgages have been at all time lows for several months. Continued economic news has kept rates from climbing, but for how long? As investors pick and choose between purchasing stocks that have been climbing and bonds, or mortgages, with high prices and low yields, what will keep them interested in bond profits in the future? Families using mortgage calculators to determine refinance mortgage savings or purchasing power for a new home loan wonder, how long will the rates stay low?

Mortgage-backed securities

From January 2009 through March 2010 the Federal Reserve Bank purchased $1.25 trillion in mortgage-backed securities on the open market. Mortgage-backed securities are essentially your mortgage packaged with millions of other mortgages into an investment bundle and sold to investors. The cash from the investors goes to Fannie Mae or Freddie Mac, Fannie and Freddie use those funds to purchase mortgages from lenders, who in turn use the funds to fund your mortgage. When your pay off your mortgage through sale, refinance or just over time, the funds are paid through your lender, through Fannie or Freddie and then to the investors to pay off their investment.

Like any investment, MBSs have prices that go up and down. When MBS prices go up interest rates go down, when MBS prices go down rates go up. When the Federal Reserve began purchasing MBSs it created its own demand and artificially increased prices, lowering rates. When the Fed mortgage purchase program began in January 2009 the Freddie Mac primary mortgage rate was 5.29 percent. In March 2010 when the program ended the rate had dropped to 4.97 percent. In the four months following the end of the Fed’s mortgage purchase program the rate has declined even further to 4.54 percent. Monthly payment calculators show that on a $200,000 mortgage the payment has dropped from $1,109 per month at the start of the Fed program to $1,018 today.

The Fed as seller?

Now that the Federal Reserve is holding over $1 trillion in MBSs what does it do with them? With the economy stalled after showing signs of recovery in later 2009 through early 2010 many are concerned that if the Fed begins dumping its MBS holdings on the market rates will rise, harming a fragile economy trying to grow. Others feel that the recent economic data shows a bump in the road to recovery and the Fed needs to be ready to sell its bond holdings and increase rates to prevent future inflation.

In the meantime because of the rapid drop in mortgage rates since March the Fed has had part of the problem of whether to hold or sell its MBS holdings solved for them. The lower rates have created a storm of refinances across the country and MBS holdings are being paid off; over $12 billion has been paid off in the final two weeks of July alone.

Future rates

Watching what the Federal Reserve does with its MBSs and other bond holdings will be important in determining whether you use continued low rates or a higher rate when using mortgage calculators. Trying to use monetary policy to help the economy shake off the current doldrums and then maintain a steady and sustained growth, the Fed has a major impact on mortgage rates depending on whether it is a buyer, a seller, or a holder.

Friday the employment figures for July will be released. Employment has become a key indicator for Fed policy. If the unemployment rate rose in July expect to see the Fed become more active in the bond markets and use the funds from paid-off bond investments to be used to purchase more MBSs and other bond investments, putting pressure on the markets for lower rates. If the employment numbers are flat expect to see the Fed start to recirculate the funds received from paid-off mortgages into new bond investments. If the numbers are positive, showing a decline in unemployment, expect the Fed to speak of divesting, or selling, its MBS portfolio in the coming months.

Whether using a refinance calculator to determine savings in your monthly mortgage payment or a pre-qualification calculator to figure your purchasing power for a new home loan, the Federal Reserve’s policy regarding mortgage-backed securities impacts your future mortgage rate.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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