Spurred by the financial debacles following the global coronavirus pandemic, the Federal Reserve slashed its benchmark interest rate to nearly zero. But while this move is designed to support the economy, it's unlikely to impact mortgage interest rates.
That doesn't mean mortgage rates won't drop. In fact, they had fallen a few weeks ago before creeping up again recently. But it's important to understand the factors that impact mortgage interest rates -- which affect your mortgage payments. That's especially true if you plan to buy a home anytime soon.
What does it mean when the Fed cuts rates?
Understand that our country's central bank, the Fed, can't wave a wand and cut all interest rates. It doesn't directly control interest rates for student loans, home loans, credit cards, home equity lines of credit, or the prime rate. It merely adjusts the only rate over which it has control - the federal funds rate.
What is the federal funds rate? It's what banks pay to borrow from the Fed's reserves to meet the needs of their depositors. (That's why its full name is the Federal Reserve Bank.) By controlling what banks pay for these overnight loans, the Fed influences how much money is in circulation. When there is more money, the economy heats up. When there is less money in circulation, the economy slows down.
Why the Federal Reserve Bank ("the Fed") cut interest rates
In mid-March, the Fed cut the federal funds rate, making the new borrowing rate range between 0% and 0.25%.
Brandonn R. Dukes, CFA, is Vice President of Mortgage Solutions at Informa Financial Intelligence. He explains that the Federal Reserve changes its federal funds rate to either stimulate or cool down the economy.
"This was done to stimulate the economy, due to the uncertainty created by the coronavirus outbreak. It was also done to ensure maximum liquidity during this time of stress on the financial markets," he says.
Dukes notes that additional liquidity allows banks to borrow money at an affordable rate; banks can then offer lower-rate loans to consumers and businesses.
"One of the fears in times of crisis is that banks will be less willing to lend money," says Phil Georgiades with FedHome Loan Centers. "The lack of cash flow can hamper a business's ability to function. By making it cheaper for banks to borrow money from the government, the hope is that banks will be more likely to lend funds to consumers."
Related: Why Do Mortgage Rates Change?
How this rate cut affects mortgages
Many people assumed that this Fed rate cut would cause mortgage rates to drop. But experts explain that this move hasn't had much of an effect on rates for home loans or the real estate market.
"When the Federal Reserve cuts rates, this applies only to the federal funds rate -- which is a very short-term rate," says David Reyes, financial advisor and chief financial architect at Reyes Financial Architecture. "Mortgage rates, instead, are typically tied to the 10-year treasury note yield."
It can actually be more complicated than that. Dukes says mortgage rates are often determined by three major factors:
- Price that investors are willing to pay for mortgage backed securities (MBS)
- Mortgage servicing values (how much servicers are willing to pay for the right to collect payments)
- Mortgage originator's revenue margin, which is set by the lender
These factors have little to do with the Fed and everything to do with how likely it appears that borrowers will default or quickly repay the loan by refinancing or selling.
Interestingly, mortgage rates have crept higher in the days since the Fed rate cut.
"This is partially due to a huge influx in refinance requests lately," Matthew Yu, vice president of Socotra Capital, says. "Lenders are overwhelmed and increasing their mortgage rates to compensate for the large demand for money.
Related: What the Fed's most recent actions mean for mortgage rates
Mortgage rate and home price forecasts
If you're thinking about buying a home, you likely have a lot of questions. Will rates drop again due to COVID-19? Should I lock in a low rate now in case rates go higher? Will home prices go up or down?
Many pros believe mortgage rates will dip lower in the weeks ahead.
"Fixed rates recently bounced up from previous lows below 3%. But after the large influx of refinances die down, we'll likely see mortgage rates drop again for both purchases and refinances," predicts Yu.
Georgiades agrees.
"Rates to consumers will be much lower in the coming weeks than they have been. But it's expected that once the economy returns to stronger growth after the coronavirus subsides, we'll see rates increase," says Georgiades. "But home prices will probably see a surge over the summer. Historically, housing prices rise in a recession because investors seek stable investments when rates fall and the stock market weakens."
Reyes isn't so sure.
"I expect a significant drop off in home sales and home prices due to the negative impact of the coronavirus outbreak. The positive here is that it could help borrowers who are in a good financial position to buy homes at much lower prices," says Reyes.
Related: Home Price Recovery Index (How Is Your City Doing?)
Buy now or wait things out?
Trying to purchase a home during a pandemic is challenging. There's the risk that your employer may cut your wages or let you go. Recommended social distancing means that it's harder to see homes in person, meet with agents, and close on time. Because lenders are so busy with refi demand, it may take longer to get prequalified for a mortgage. And what if you get sick before you can complete the transaction?
Still, if you have strong job security, are healthy, and are in a safe financial position, now could be a great time to score a deal on a home purchase. Just realize that the process may take more time and patience than you expect.
"This is a good time to take out a mortgage because interest rates are lower than they have been in a while," suggests Georgiades. "If you're ready to buy, it may not pay to wait things out in the hopes that mortgage rates go lower."
Doug Leever, mortgage sales manager with Tropical Financial Credit Union, seconds those thoughts.
"It doesn't hurt to shop around, work with a trusted agent and lender, and review rates, fees and terms," says Leever.
Others recommend taking a wait-and-see approach.
"I would be more inclined to wait due to the uncertainty around the coronavirus and its effect on the economy, unemployment and consumer confidence. Plus, I think home prices will likely fall, making a purchase more affordable later on," says Reyes.