The banking system in the USA is in crisis. The Fed is lowering interest rates, yet mortgage interest rate predictions are still rising – how can this be?And what does it mean for home owners?
The relationship home owners need to grasp to understand interest rate predictions is the interplay between interest rates set by the Fed and mortgage interest rates charged by mortgage lenders.
Interest rates determined by the Fed affect the cost of borrowings for mortgage lenders. Banks and other lenders don’t have all the funds they lend out as mortgages – they actually borrow 90% of what they lend out to home owners on the wholesale market at interest rates lower than the rates they charge home owners on their mortgages.
When the Fed lowers interest rates, it lowers the costs to mortgage lenders, so you would think that interest rate predictions would fall. However, mortgage lenders may choose not to pass on the reductions to mortgage holders.
The reason is not corporate greed – there is plenty of competition in the lending market to ensure that no lender can profit excessively. The reason is that lending against homes is now a whole lot more risky, and increased risk raises interest rates.
Mortgage lenders are charging everyone more interest to offset their losses on the few who will fail to pay their mortgages.Until the housing market stabilises, default risk will remain high, and interest rate predictions will remain high.
There is a limit to how much the Fed can lower interest rates, too. The primary interest rate (called the “nominal” rate) includes inflation. To find the “real” interest rate, you need to subtract the inflation rate from the nominal interest rate.
Right now, when you do that, the result is a negative number! This means that nominal interest rates are less than the rate of inflation.
As you can imagine, this is a situation that just cannot continue. The Federal Reserve will have to raise interest rates to at least break-even levels, matching the rate of inflation. This coming interest rate rise will obviously flow through into mortgage interest rates.
What we are saying is that it’s really only a matter of time, and not much time, before mortgage rates rise again.