Subprime Wolves are Howling About Mortgage Rates and the Fed Funds Rate Reduction

Yesterday’s reduction of the Federal Funds rate to a range of 0.000 to 0.250 percent is the lowest record level in history. This news is certainly in the minds of many consumers but, as also explained by Dan Green, it is for the wrong reasons!

Every time the Federal Reserve reduces interest rates, I hear radio and television personalities (i.e.: agents and broker) rambling about how “The Fed reduced rates today and that translates into lower mortgage rates so now you can refinance/buy with an even lower rate.” Well….they are either a lying to you with that sales pitch, they don’t know how mortgage rates work, or both.

Now, let’s look at how all these rates really work so you don’t have to rely on a wolf howling to refinance your home.

Federal Reserve (The Fed)

The Fed is a central banking system with several components. One of these components is twelve regional Federal Reserve Banks located in major cities throughout the US – we have one here in San Francisco. Its role as a central banking system is to serve as a bank for other banks. Also, it serves as the government’s bank and it holds the U.S. Treasury’s account. Such account is funded with the government revenues (i.e.: the taxes we pay every year). The Fed’s decisions do not have to be formally approved by the President or the executive branch of our government.

Federal Funds

The federal funds are the reserve funds that private banks keep at their local Federal Reserve Bank. Member banks, customer banks of the Fed, are required to maintain their accounts according to certain Federal Reserve requirements in order to clear their financial transactions. So, basically they need to keep a balanced account just like you and I do with our own personal checking accounts in order to clear our checks.

Federal Funds Rate a.k.a. Overnight Rate

Banks that need money, in order to meet their requirements, borrow reserves from other member Banks that have excess in reserves. These loans made between banks are usually made at the close of one business day and to be repaid at the start of the next day. The interest rate charged on these overnight in-between-bank loans is called the federal funds rate, and hence the nick name “overnight rate.”

Discount Rate

Banks can also borrow funds directly from their local Fed. The interest rate charged on these loans is the “discount rate.” Both the fed funds rate and the discount rate influence the prime rate.

Prime Rate

The prime rate is used by lending institutions for their loans made out to credit worthy customers and corporations. This rate is used as an index for calculating the adjustments to ARM loans and other variable rates short term loans (i.e.: credit cards loans, home equity lines of credit, student loans).

Mortgage Rates

Although the fed funds rate movements do have an indirect impact on mortgage rates, fixed mortgage rates are in a different ball game. This is because they are tied to long-term bond yields which are bought and sold in Wall Street just like any other stock.

The lowering of the federal funds rate will certainly affect you – whether you are a homeowner, renter, or investor – but not in the way you will hear from the howling of a subprime wolf.

Word of Advice

As I mentioned it on a previous post, the lowering of the fed funds rate has positive and negative effects on your money. Therefore don’t make a decision to refinance or buy a home simply because the Federal Reserve cut rates, make that decision base on your individual financial situation.

Finally, if you hear an agent, broker or company using the sales pitch of how the fed funds rate cut will lower mortgage rates for a refinance, listen a little closer (but not too close) and you may also hear the howling of a wolf.

December 17th, 2008 · Filed Under Mortgage - Loan Information

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One Response to “Subprime Wolves are Howling About Mortgage Rates and the Fed Funds Rate Reduction”

  1. Pimps and Whores of the Loan Modification Industry : San Jose-Santa Clara County Real Estate UNCENSORED on January 12th, 2009 4:53 PM

    [...] Furthermore, it includes licensed and non-licensed individuals with no ethics also known as the “subprime wolves.” Some of them have prior convictions and indictments ranging from “petty theft” to [...]

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