The Fed is losing control of the financial system. The Federal Reserve is lowering prime interest rates, yet mortgage interest rate predictions are still shooting up – what’s going on?And what will it mean for the average American?
The idea that home owners need to understand when it comes to interest rate predictions is how the interest rates set by the Fed and mortgage interest rates charged by mortgage lenders are connected.
The interest rates which are set by the Federal Reserve determine the cost of borrowings for 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.
When the Federal Reserve lowers interest rates, it lowers the borrowing costs for mortgage lenders. You would think, in that case, that interest rate predictions would fall. However, banks and other lenders may choose not to pass on the reductions to home owners.
The reason is not profiteering – there is enough competition in the mortgage lending market to ensure that no one lender can profit unfairly. The reason is that lending against homes is now a whole lot more risky, and increased risk raises interest rates.
Lenders are charging everyone more interest to cover their losses on the few who will default on their mortgages.Until the plummeting housing market levels out, the risk of default will be high, and interest rate predictions will keep rising.
The Fed can’t lower interest rates indefinitely. The apparent interest rate (called the “nominal” rate) includes the rate of inflation. To calculate the “real” interest rate, we subtract the inflation rate from the nominal interest rate.
These days, when you do that subtraction, you will see a negative number! This means that nominal interest rates are less than the rate of inflation.
Obviously, this is a situation that simply cannot continue for very long. The Federal Reserve will have to raise interest rates to at least break-even levels, matching the rate of inflation. When it comes, the interest rate rise will immediately flow through into mortgage rates.
In other words, it’s only a matter of a short time before mortgage rates rise again.
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