There is a lot of murmuring regarding the federal funds rate increase yesterday by Federal Reserve Chair Janet Yellen. It’s the first increase since 2006 and brings a lot of attention I think because of our recent history. See the article and video on this which also mentions possible future increases: http://www.bizjournals.com/bizjournals/washingtonbureau/2015/12/yellen-says-fed-is-raising-interest-rates.html?ana=fbk
Ben Bernanke prior Federal Reserve Chair slowly decreased this rate until it was at zero during the Great Recession and Housing Crisis in efforts to stimulate a crashed economy. It did help along with other government bailouts, we can see looking back, as we are out of the recession and housing has stabilized. Some of Alan Greenspan’s quotes speak for themselves of a major factor in the Great Recession:
“ I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant”
― Alan Greenspan
“We had a bubble in housing.”
― Alan Greenspan
“government regulation cannot substitute for individual integrity.”
― Alan Greenspan, The Age of Turbulence: Adventures in a New World
I was a Mortgage Loan Originator before and during the housing crash. I remember the many Correspondent Lender Account Executives pushing more and more loan products making it easier and easier for one to get a mortgage. There was a time when one could do an 80/20 (80% first mortgage, 20% second mortgage) thus zero down with a credit score of 620. There were also loan products of no income verification, stated income, no document loans, & no ratio loans (referring to debt to income ratio). The result many got into the housing game of flipping. Buying knowing they couldn’t afford the mortgage and banking on that they would sell quickly and make a profit. I remember thinking how this could go on? How could a housekeeper and a gardener buy a 600K house when their combined take home income would barely cover the mortgage payment? This lending occurred due to deregulation of which both Greenspan and Bush supported.
When the mortgages stopped performing, new owners defaulting even on their first mortgage payment, in numbers of tens of thousands+, the result was the housing bubble burst which was so severe it put our country and rippled to other countries into recession. The feds then were closing the barn doors after the fact with over regulation which made it extremely hard for even strong borrowers to get mortgage loans. Of course the obvious of unemployment & job instability meant many could not qualify for a mortgage and those that already had mortgages became underwater with the plummeting values. The outcome enormous amounts of foreclosures and short sales further weakening the economy. Back in my lending days, a condition underwriters imposed was written verification of employment that borrowers jobs and pay were likely to continue. How many employers do you think were willing to put that on paper during the Great Recession?
Markets seek to correct themselves.
Now that the economy is once again healthy, Janet Yellen has increased the federal funds rate because: ‘Yellen said the Fed wants to make sure that inflation — which is now well below the Fed’s 2 percent target — doesn’t overheat at some point and forces the Fed to raise rates abruptly. That could push the economy into recession, she said. So it’s prudent to slowly normalize monetary policy now, she said.’
But what is the federal funds rate and how does it affect mortgage interest rates? According to Wikipedia: ‘In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis. Reserve balances are amounts held at the Federal Reserve to maintain depository institutions’ reserve requirements. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances. The federal funds rate is an important benchmark in financial markets.[1][2]
The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.
The federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which normally occurs eight times a year about seven weeks apart. The committee may also hold additional meetings and implement target rate changes outside of its normal schedule.
The Federal Reserve uses open market operations to influence the supply of money in the U.S. economy[3] to make the federal funds effective rate follow the federal funds target rate.’
Here is a layman explanation that we can relate to by Todd Perry: ‘When money is deposited with a bank, the bank turns around and lends that money out. However, the Fed requires the bank to maintain a certain percentage of those deposits as a reserve, in case depositors want to draw money out. When a bank has excess reserves, they are known as federal funds because they are held on deposit in regional Federal Reserve banks. Sometimes a bank wants to lend out more money than it has, so it borrows it from a bank that has excess reserves. When one bank borrows money from other bank, the rate that is charged is the federal funds rate.
Sometimes, because of an unusually high demand for loans or a sudden demand for withdrawals, the amount of money the bank has as a reserve falls below the required percentage. When that happens, the bank first tries to borrow from other banks, then it tries to borrow Eurodollars, then it tries to borrow using repurchase agreements (which are loans secured by government debt obligations like T-Bills) and finally it goes to the lender of last resort — the fed. The rate the fed charges them is the discount rate.’ https://www.quora.com/What-is-the-difference-between-the-Fed-Funds-Rate-and-the-Discount-Rate
So why the concern mortgage interest rates are going up?
What drives the mortgage interest rates is the yield on the 10 Year Treasury Bond. When the yield is higher, the mortgage interest rates go up and when it is lower, the mortgage interest rates go down. Usually the stock market and treasury bonds are opposing forces relative to mortgage interest rates. When the stock market is doing poorly, investors put their funds into the safety of guaranteed rates such as treasury bonds thus decreasing its yield. Back in my lending days and continuing as a Real Estate Agent, I teach my clients this concept and show them how to track and anticipate mortgage rates by monitoring this yield which is quite useful especially when considering to lock-in a mortgage interest rate.
The federal funds rate does not directly and immediately affect mortgage interest rates. However, eventually it will as the varying markets all affect each other.
