Thursday, October 30, 2008

Mortgage Rates and the Federal Funds Rate

Q: Why don't mortgage rates go down when the Federal Reserve lowers the fed funds rate?

A: The federal funds rate is the rate that banks in the Federal Reserve system charge when they lend money to each other, usually on a very short-term basis (as short as one day). The Prime rate is 3% higher than the fed funds rate, and is what banks use to determine the interest rate for Home Equity Lines of Credit (HELOCs). However, long-term mortgage rates are determined by what large, long-term investors (mutual fund managers, foreign governments, other fabulously wealthy types) are willing to accept as a return on their investment money. The best indication of whether mortgage rates are going to go up or down is the yield on the 10-year Treasury note, which changes all day long, depending on the trading in the bond market (just as stock prices change constantly, so do bond prices). Mortgage rates are always a bit higher than the 10-year yield.

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