While the Fed Funds Rate reduction does not directly affect mortgage rates it does have an impact on the interest rates investors utilize. When we read in the paper about how the Fed has slashed interest rates, the rate that has been cut is the lending rate between banks and other depository institutions. As the interest rate decreases for banks to borrow money, the bank in turn passes this reduction to the general public. Mortgage Backed Securities dictates conventional interest rates; it is the demand of the market that causes rate increases and decreases. However, rates tend to pattern the Fed, but they are not set by the Fed. The interest rate that real estate investors should be paying attention to and that can be directly correlated to the Federal Reserve, is the Prime Rate. The Prime Rate was at 8.25% in September 2007 and now it is at 6.00%. That 2.25% means substantial savings for all investors that utilize lending tied to prime.
There are several ways to finance your rehab project: hard/private money, cash, credit cards, or home equity lines of credit (HELOC). A number of investors utilized lines of credit on their primary home or existing investment properties to rehab their projects. This is becoming even more favorable because all HELOC’s are tied to prime. If you had your HELOC prior to September 2007 you have seen a 2.25% rate reduction. On a $50,000 HELOC the rate reduction saves you $93.75 a month.
Prime Rate has a similar affect on financing of spec homes or construction loans. Most spec and investment properties are financed with interim construction loans. These loans are based on a margin -/+ Prime Rate. Once again, since September there has been a 2.25% rate reduction. On a $417,000 loan amount this equates to a $781.88 monthly savings on the debt service.
While the Prime Rate is seldom used to secure an investment property long term, it is worth mentioning how the Fed Funds Rate can help the average investor cash flow. Historically conventional interest rates have followed the direction of the Fed; this has caused the interest rate to decrease significantly since September. There are a number of variables on investment properties, but if an investor can qualify by having great credit, documented income, assets and have 30% equity into their property, rates have been as low as 5.5% on a 30 year fixed over the last month. This is only an illustration. Please contact your trusted mortgage advisor to check your specific scenario.
With more potential rate cuts in the near future 2008 is a very good time to be in the real estate investment arena.