How the Recent Fed Moves Might or Might Not Affect Mortgage Rates

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I read this article today by someone high up at First Heritage Mortgage. I was so impressed by how well he explains what the rate cut might mean to mortgages that I asked him for permission to repost to my blog. He generously agreed, but asked that I not use his name. Here you go!

As many of you know, the Fed made an unusual move and held an emergency meeting on Sunday instead of waiting until their regularly scheduled two-day meeting this week on Tuesday and Wednesday.  The result of the meeting was the announcement of some major policy shifts. They are as follows:

  1. They cut the Federal Funds Rate to 0% (This is NOT Interest Rates – more on this later)

  2. They announced they will be buying at least $500 Billion in US Treasuries and $200 Billion in MBS (Mortgage Backed Securities) This is what could eventually help rates – more on this below as well.  This is known as QE (Quantitative Easing and is the reason rates dropped during the great recession.  This was the FED’s way to help stimulate the economy, which did work.)

  3. The purchase of the first $40 Billion will happen today.

  4. They announced that as loans the FED currently owns get paid off through refinance or sales, they will re-buy more loans with that money as well.  This is in addition to the $200 Billion above.

  5. Finally, the FED announced they are cutting the reserve requirements for thousands of banks to zero.  This is important because it relieves the banks of the need to hold on to capital to meet federally mandated reserve requirements and gives them the flexibility to have those funds available to loan among themselves to help each other out and keep liquidity in the banking system. 

 
I know that some of this above may mean nothing to you so please allow me to explain a few things from above.

  1. The Fed cutting the Fed Funds Rate to 0% does not mean interest rates on mortgages will go down.  Certainly not to 0%!  Could it eventually help? YES.  However, even if rates could come down there is a much bigger issue that has to be dealt with first.  That is the CAPACITY for the mortgage industry to handle all the mortgages.  Consider this.  There are $11 Trillion in mortgages in the US.  About half of those ($5 Trillion) are currently eligible for refinance.  In a great year in the mortgage industry there are about $3 Trillion in mortgages produced in 1 year.  If half are purchases, that means about $1 ½ Trillion in refinances are done by the entire mortgage industry.  Even if the industry does a heroic job of doing refinances to satisfy all of the demand and does $2 Trillion or $2 ½ Trillion in refinances, there is physically no way to do all of the refinances in one year.  So, the CAPACITY of the industry cannot handle all of the business that is out there to be had so why would they lower rates to generate MORE business when they cannot handle all of the business that is currently there?  Think about it another way, if Apple has a new phone go on the market and lines are around the block with people waiting to buy the new phone, they don’t put it on sale.  They couldn’t handle the business and there is no need to put it on sale.  It is sort of the same thing with interest rates.

  2. The FED buying $200 Billion in Mortgage Backed Securities (MBS).  This is actually the thing that can help rates drop eventually.  This is because as long as there is a good buyer for MBS, then this will make sure that the mortgages that are closed have a buyer on the secondary market.  With the FED jumping in to buy $200 Billion and also replacing the loans that are already on their books when those are paid off through refinance or sale of the home, this helps with one side of the capacity issue.  The other side of the capacity issue is the simple fact that the mortgage industry (mortgage companies, title companies, appraisers, etc.) all have to be able to get caught up with the huge amount of recent business that they have taken in.  This will happen, but just takes time.  When it does, there is a good chance that rates will drop some.  How far is anyone’s guess but do not expect them to go down to 0% and don’t expect the rates to drop right away.  Any rate drop will be gradual and measured.  Rates could even move up a little depending on the capacity issue I explained above.  That would simply be the industry self-regulating to slow volume to allow for things to get under control.

 
In summary, we are in uncharted territory in our country right now.  With the Coronavirus going on, people having to work from home and avoid much interaction, there are all sorts of things that we are not used to.  As an industry, we are busy trying to keep things going from our end and will continue to work on what we can do.  As the current loans in the system close and more capacity becomes available to handle additional new mortgages, the FED’s Sunday moves may in fact cause interest rates to drop over time.  Hopefully, my explanation above will help you understand that this will not happen immediately.  The good news is, mortgage interest rates will likely stay low for quite some time.  There is no reason for people to panic and think they are going to MISS the opportunity.