The Federal Reserve made an announcement on September 13, 2012 about their plans to support a stronger economic recovery. This was a much anticipated announcement, because of what the actions will do to mortgage rates and the overall economy in the future.
The two major actions the FED plans on doing as part of this QE3 are:
- Purchase additional mortgage-backed securities at a pace of $40 billion per month.
- Extend the target range of the federal funds rate at 0 – 0.25% percent through mid-2015.
Bond Prices and Mortgage Rates
When the FED purchases mortgage-backed securities, they keep the demand high for bond prices. When bond prices are high, mortgage rates fall. Mortgage rates should stay around the same average they have been most of this year. The FED has helped keep the mortgage rates at historic lows, which drives buyers to buy homes, since the combination of very low interest rates and cheaper housing prices will motivate many buyers. Lower mortgage rates have also opened up the opportunity for homeowners to lower their interest rate by refinancing their mortgage. Lower interest rates, will lower their monthly payment — the hope being that by giving homeowners more money with lower payments, the remainder will in turn be put back into the economy.
The question many people wonder is when the FED decides to no longer purchase these securities to keep bond prices high, how will this affect the interest rates in the future? Will they increase to 5%? 6%? We all know that when mortgage rates rise, mortgage payments rise. In turn, the purchasing power for buyers is lower and this reduces the sale of homes.
The Federal Funds Rate
The federal funds rate is the interest rate at which banks borrower from each other. The whole point of the federal funds rate is to motivate investors to borrow money at little to no interest. They then use this super cheap money to lend more money to people and businesses. In theory, the more money that investors lend to people, the more this will stimulate the economy.
The FED is also encouraging investors to expand on mortgage programs and loosen guidelines. This will open up more oportunites for borrowers to get pre-approved to buy homes and homeowenrs to refinance to lower their payments. There is a lot of fear from investors, since defaults are a big concern. If investors don’t have confidence in the economy, they will be hesitant to borrow more money, even if the interest rate is next to nothing. Some investors see big opportunities being able to borrow at 0% percent interest. We are seeing this in the mortgage market with new investors coming out with mortgage programs and expanded guidelines.
What do you think about all this help from the FED? Some say we are spending way too much money. Some say the real estate market is the back bone of our economy, so an effort to keep interest rates low and expanding mortgage programs will encourage people to buy homes and stabilize the market faster, in order to avoid further disaster.
Photo: Sébastien Bertrand