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If Rates Rise …

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Posted On: 07/13/2016

QUESTION:

It’s expected that the Fed will raise interest levels this summer. How will that impact mortgage rates?

ANSWER:

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The fact is that mortgage rates have plummeted since the Fed raised bank rates in December, going from 3.97 percent just before the Fed announcement to 3.58 percent in mid-May, according to Freddie Mac.

When it’s said that the “Fed will raise interest rates” it should be mentioned that an action by the Fed does not raise all rates. The Federal Reserve, in particular, does not control mortgage rates.

The worry for mortgage borrowers is that a Fed rate hike might impact rates generally and then, as an indirect result, mortgage rates might increase.

Why does the Fed want higher interest rates?

To keep the economy humming along, the Fed wants to see inflation at about 2 percent per year. This level of inflation is regarded as attractive because it’s thought to spur consumer purchases – if prices will be higher tomorrow, then you have a reason to buy today. If more people buy today, that boosts sales and the economy can grow nicely. Without inflation maybe consumers won’t buy today because higher prices do not loom in the future, so a big incentive is gone.

However – and this is a big deal – while the Fed can directly set rates, which force bank interest levels up or down, it does not control mortgage rates.

Instead mortgage rates float with the market, bobbing up and down daily if not more often. That’s a worry when rates rise and a joy when they fall. As this is written, U.S. mortgage rates are less than 4 percent, a reason for elation when compared with rates during past decades.

If mortgages only came from banks, then the Fed’s impact would be far greater, but that’s not the case. The funding for mortgages – the cash put up by lenders – comes from all over the world and you don’t have to visit a bank to get it. Nonbanks – lenders who do not have depositors, branches or ATMs – now account for almost half of all the mortgages sold to Fannie Mae and Freddie Mac.

Most importantly, there is plenty of capital available at rates, which are below the interest levels set by the Fed. For example, there’s an estimated $9.9 trillion, according to Fitch Ratings, now invested worldwide with negative interest rates – rates that are less than zero.

If the Fed raises rates, mortgage lenders simply can get capital at less cost from any number of sources, including overseas sources that would be elated to earn positive rates inside U.S. borders.

Another rate hike from the Fed means only that higher-cost capital will have to compete with the lower-cost cash now widely available. If you’re a borrower, which would you prefer?

Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to peter@ctwfeatures.com.

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