Interest Rates Forecast
September 24th, 2008 by Mark FlandersThe banking system in the USA is in crisis. The Fed keeps lowering Federal interest rates, but mortgage interest rate predictions are still going up – how can this happen? And what might it mean for home owners today?
The relationship home owners need to grasp to understand interest rate predictions is the interplay between interest rates set by the Fed and mortgage interest rates charged by mortgage lenders.
Interest rates that are set by the Fed flow into the cost of funds to mortgage lenders. Banks and other lenders don’t possess all the funds they lend out when a mortgage is written – they borrow on the wholesale market 90% or more of what they lend out to home owners, at interest rates lower than the mortgage rates they charge home owners for their mortgages.
Banks make their profits from the difference between what they pay when they borrow money, and what they charge when they lend it out.
When the Federal Reserve lowers interest rates, it lowers the borrowing costs for financial institutions, so you would think that mortgage interest rate predictions would fall. However, financial institutions may choose not to pass on the savings to mortgage holders.
The reason for this is not greed – there is adequate competition in the mortgage lending market to ensure that no bank or other lender can profit unfairly. The real motivation is that being a bank that lends for mortgages just became a whole lot more risky, and risk tends to make banks raise interest rates.
Financial institutions are everyone more interest to compensate for their losses on the few who will miss payments on their mortgages.Until the current housing market settles, risks for lenders will remain elevated, and mortgage rates forecast will continue to be high.
The Fed can’t lower interest rates indefinitely. The actual interest rate (called the “nominal” rate) includes inflation. To find the “real” interest rate, you need to subtract the inflation rate from the nominal interest rate.
Today, when you do that, you get a negative number! This means that nominal interest rates are not even high enough to keep up with inflation.
Clearly, this is a situation that cannot continue for long. Sooner or later, probably sooner, the Fed will have to raise interest rates to at least break-even levels, matching the rate of inflation. As soon as it happens, the prime interest rate rise will flow through into mortgage interest rates. The only way is up for the mortgage interest rate forecast.
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