Interest Rates and Mortgage Market Stability

Mark Jones

With the credit market reeling what has the Federal Reserve done and what can it do to alleviate the overall concerns in the mortgage market?

The Fed recently stepped in and made an unexpected cut to the discount window rate, which was great news for the mortgage market reducing liquidity concerns and providing stability in the overall financial markets.

How does this provide stability? Here’s an example: it’s the middle of the winter in the Northeast and you wake up to a howling ice-storm and realize a tree has fallen on your roof causing $10,000 in needed repairs. Even though you know your insurance company will cover the cost of the repairs your contractor requires half of the money up front, creating a short term need for cash. So, do you sell some stocks to get the cash, or pull out a home equity check? More than likely you write a home equity check rather than liquidating a long-term investment since you will pay the loan off in a couple of weeks when the insurance claim is processed.

This is similar to the scenario banks are facing in today’s liquidity crunch as the Fed’s cut to the discount rate helps them avoid long-term damage by supplying access to short-term cash. In other words, it put a floor under the market to stop its freefall and give investors, borrowers, etc. time to process what is transpiring and to realize that, though there are concerns in the market, things aren’t as glum as they appear.

It is important to note that although the discount rate is a powerful tool for the Fed — and one that has a strong influence on the market — it does not directly impact home loan rates. Home loan rates, home equity lines, auto loans, etc. are more directly impacted by the Federal Funds Rate, which is the rate now under the scope at the upcoming Federal Reserve meeting. The Federal Funds rate is set by the Federal Reserve and is the interest rate for overnight loans between banks. With the downturn in employment numbers, the continued pullback in housing sales, etc., the forecast is for a second drop in the Federal Funds rate to by ¼% - ½%, following on the heels of last month's ½% drop. These drops will add support to the markets and hopefully adding a little more stability to what has been a volatile market over the last few months.

Information, knowledge, and expertise are the building blocks of sound financial decision making. If you are embarking on a new home purchase, home improvement project, or the like I encourage you to seek the knowledge and resources of a skilled mortgage professional.

For additional information visit www.askmarkjones.com.

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