Federal Reserve Dooms Higher Interest Rates For Savers

For those of us who are waiting for the Federal Reserve to increase interest rates that banks have to pay to borrow money, our waiting has gotten much longer, at least two years longer. Since the Fed’s rate-setting committee decided to hold interest rates at the current record lows until ‘at least through mid-2013’, we cannot see interest rates increasing on any investment vehicle such as Certificates of Deposits, Savings Accounts or any other investment that relies on the interest banks pay.

What does this mean for savers?

Banks will continue to borrow money at near zero percent interest and basically will have an endless supply of cash from the Fed. Why would a bank pay a higher interest to its savers/investors if it can get the same amount of money from the Fed at 0%-0.25% interest? Since these interest rates will be held at or near zero percent until at least mid-2013, savers get the short end of the stick!

What does this mean for mortgage rates?

The only good news about interest rates staying at record lows goes to those of us buying houses, cars or other items that require a loan of some type. The whole idea of keeping interest rates low is to encourage people to buy bigger houses and cars, and to encourage businesses to hire and expand their businesses. Neither of these scenarios has been working. The real estate market continues to struggle, more and more people are losing their homes to foreclosure and less people are able to qualify for a refinance on their current home mortgage, thus missing out on these record low mortgage rates.

The thought of keeping interest rates at record lows was to help the struggling economy, to help business create more jobs, to help the failing housing market, to increase consumer spending and to boost manufacturing outputs, but none have seen a boost or an increase in productivity. So why does the Fed keep doing the same thing by keeping record low interest rates until mid-2013? Not only does this do anything for the struggling economy but also hurts savers and investors alike. CD rates will continue to stay at or near record lows and mortgage rates will look to stay around record lows until inflation hits. We can see that both CD rates and Mortgage rates sticking around these low rates for a long time to come, unless if the US economy picks up, inflation hits or the Fed decides to change course.

What Does it Mean for Mortgage Rates when the Feds Cut the Prime Rate?

Every so often you will hear that the feds are cutting the prime interest rate.  When I was a loan officer I would get inundated with phone calls from clients after an announcement like this.  Over and over I would have to explain to them how the feds interest rate cut does not directly affect mortgage rates.

Here is why.

When the Federal Reserve (the Feds) raise or cut interest rates they are changing the prime rate of short term loans.  Short term is the key here.  Short term loans are loans such as auto loans or lines of credit.  The most simplistic way to describe it is that banks and lenders use the prime rate as there base and any additions to the rates they offer on short term loans get added onto the prime rate.

If you have an adjustable rate line of credit and the Feds cut the prime rate by .25%, the rate on your adjustable line of credit will decrease.

Now long term loans such as mortgages are based on an entirely different system for determining what the rates will be.  Explaining this system is another article entirely, but has much more to do with the bond markets and mortgage backed securities.

The rate cuts or rate hikes from the feds has absolutely no direct affect on long term loan rates.  Now it can have an indirect affect on them just not directly.  Sometimes long term rates do not do anything when the Feds meet.  Historically long terms rates are just about split when it comes to going up or down after the prime rate has been cut.

Check out Average Closing Costs for a Home Mortgage.

Short term loans and long term loans have two completely different methods for determining interest rates.  Using one to help gauge the other means you will be misinformed.

If you are in the market for a mortgage be sure your loan officer has a good pulse on what is happening with long term rates.  Right now it is pretty easy; they are low, really low.  But when the economy starts making headway it is going to be a different game.  Educate yourself and surround yourself with professionals who can help you make the right choices.

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