With the federal reserve cutting the fed funds target rate from 5.25% to 4.75% and the discount rate from 5.75% to 5.25% earlier this week, many people assume that mortgage rates will now go down as well. But this isn't necessarily true.
Banks can borrow from each other (federal funds) or directly from the federal reserve (at the discount rate) to help meet their reserve requirements. (Wikipedia provides a good basic explanation of reserve requirements and the role of the federal reserve: http://en.wikipedia.org/wiki/Federal_funds_rate#See_also)
Most banks set their prime rates based on the fed funds rate target. And that is what we saw this week; major banks lowered their prime rates following the fed's cuts.
Rates for home equity lines of credit (HELOCs) are often based on the prime rate. And therefore most homeowners with a HELOC will see their rate reduced by .5% (matching the percentage of the prime rate decrease).
But mortgage rates (home loans) are based on investors' expectations of inflation. If investors feel inflation will go up in the future, today's mortgage rates will increase. Whether the investors are right or not doesn't matter; it's their expectations of future inflation that impact mortgage rates.
And with the fed's rate cuts, many investors are betting the cheaper money environment will cause an increase in inflation. Because of this expectation, mortgage rates actually increased this week despite the fed's actions.
So while the fed rate cuts may help alleviate the recent seizures in the credit markets, don't expect mortgage rates to automatically go down because of them.
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