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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