There is a lot of confusion regarding interest rates. I received a few e-mails and some phone calls asking if it was now a good time to buy real estate since the Fed cut interest rates. I replied that the Fed rate doesn’t affect home mortgage rates. The two are completely different animals. In fact this week home mortgage rates went up after last weeks rate cut.
To make my point I have plotted the 30 year mortgage rate and the federal funds rate on the same graph. (Red = Federal Funds Rate, Blue = 30 Y Mortgage Rate)
The only way the federal funds rate affects home mortgage rates is via the general economy. There is no one-to-one effect, neither is there an implied effect. Any effect you may see on this graph is the result of economic factors rippling through the market as the Fed changes the federal funds rate.
As you can see (on graph) there is no direct relationship. It’s not like you can increase one and the other automatically goes up or down. In the early 1970s there is a lot of back and forth movement. You may say that recently there is more of a relationship, but if you were to dig deeper you would see that no statistical relationship exists. We may see some kind of broad pattern but that is a function of overall economic conditions (which effects both rates) than the federal funds rate directly influencing home mortgage rates.
Just so you are aware, home mortgage rates are determined by Mortgage Backed Securities.
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on Sep 25th, 2007 at 3:01 pm
Great blog entry! I think too many assumed that mortgage rates were going to drop as a result of the rate cut. The cut just motivates the economy to spend!
on Sep 25th, 2007 at 7:10 pm
I totally agree with your view. This a great article, clearing up the confusion.
on Sep 25th, 2007 at 9:36 pm
Excellent analysis Shailesh! I swiped the chart and posted it (with appropriate linkage), but let me know if you want me to pull it.
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on Dec 15th, 2008 at 10:59 pm
It would be incorrect to state that there is a *direct* relationship between fixed mortgage rates and the Fed Funds rate, but there definitely is significant correlation between the two. Lots of things usually happen when the Fed cuts rates; I say usually, since things are working a bit differently now given that the market seems psychologically bounded. Ok, Fed cuts rates, the costs of lending goes down for banks on a short-term basis. So, of course, the rate on a 30-year mortgage isn’t going to drop lock-step with a near quarterly-adjusted OVERNIGHT rate, but the correlation IS there because of its impact on the capital markets as a whole and, in more recent years, due to utter disregard for responsible risk management.
A better benchmark would be the yield on a 10Y treasury bill. The yield for these tend to correlate very strongly with the 30Y mortgage rate since 10 years is how long it takes, on average, for these mortgages to be paid off. Again, these are all things that happen under normal circumstances. The markets have gone haywire. Mortgages, including mortgage-backed securities were generally considered very safe fixed-income investments. That’s gone out the window and the spreads between mortgage rates and 10Y notes have hit historical highs.
on Dec 17th, 2008 at 9:13 pm
Your point is very well taken. I would add though I have seen enough data to not even use the 10Y treasury as a benchmark. The best of course are Mortgage Backed Securities.
Thanks for your feedback.
on Jun 28th, 2009 at 12:25 pm
i’m not an expert but that graph shows that there is some relationship, it certainly does NOT show that they are not related.
if banks can borrow money cheaper then they will lend it cheaper.. no? thoughts from experts?