Shmuel Shayowitz (NMLS#19871) is President and Chief Lending Officer at Approved Funding, a privately held local mortgage banker and direct lender. Shmuel has over two decades of industry experience, including licenses and certifications as a certified mortgage underwriter, residential review appraiser, licensed real estate agent, and direct FHA specialized underwriter. Shmuel provides a uniquely holistic approach to comprehensive real estate and financial matters that goes well beyond any single transaction. Shmuel is an award-winning financier recognized for maximizing the short-term and long-term objectives of his client. As a contributing writer to many local and regional newspapers and publications, his insights have been featured in the media for many topics, including mortgages, personal finance, appraisals, and real estate trends.
In a few days the Federal Reserve will be making their long awaited decision on interest rate policy. All the money is on a rate increase of presumably 25 basis points. The decision will likely cause much volatility – pulling money into or out of the bond markets depending on the positioning of bond traders. Clearly the change of Fed policy on rates will cause movement for mortgage rates.
Before we can determine the effect that a Federal Reserve rate change has on mortgage rates however, it is important to know that the Federal Reserve does not control mortgage rates whatsoever. The Federal Reserve has the ability to control important instruments such as the “discount rate” and “fed funds rate,” which ultimately influence other market indices, but that is the extent of their ability.
Federal Funds Rate
The federal funds target rate is a short-term rate objective that is set by the Federal Reserve Board at its FOMC meetings. This rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The real rates may change intermittently but it is usually very close to the target rate desired by the Federal Reserve.
The discount rate is the interest rate that banks pay when they borrow money directly from the Fed, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions. The rate has been largely symbolic in the past and is typically at least one percent higher than fed funds rates. Because of this, hardly any banks utilized this source or method of obtaining funds except during emergencies.
The prime rate has generally been known as the interest rate that is charged to the most creditworthy bank consumers. These loans are typically extended to things such as credit cards and home equity lines of credit, as well as most small business loans. The prime rate is directly tied to the fed funds rate, normally three points higher than the published fed funds rate. In recent years, the prime rate has been offered to all types of consumers for various loan types and typically acts as a starting point (base) rate at which banks tie their loan rates to. These rates are generally variable and subject to change every month based on the published prime rate in effect at the time.
The Fed Effect
Now that we have a better idea of the different rates in the marketplace, we see that the only direct effect to a consumer is through the change in the prime rate. Should the Fed increase the targeted fed funds rate, consumers will be affected by receiving a higher rate on their prime-based loans as indicated above, beginning the following month after a rate increase.
Preparing For A Rate Decrease
There is a very common and very wrong misconception that if the Fed were to raise “rates” mortgage rates will go up. That’s not the case whatsoever. The last Fed rate increase was in December 2015 after years of inaction. Immediately following that rate decision, mortgage bonds rallied and mortgage rates improved in the short-term. Chances are we may see the same. Homeowners and consumers should be using the time now to evaluate all of their outstanding loans and debts to see if consolidation is a viable option for them and how it would compare in a market with higher prime rates.
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