The Mortgage Reports Blog

Because The Fed Raised The Fed Funds Rate, The Cost Of Credit Moved Higher

Tuesday, the FOMC raised the Fed Funds Rate by 25 bps, or 0.25%. Markets took the news in stride and mortgage rates remained relatively stable.

A role of the FOMC is to regulate the United States monetary policy and the quarter-percent increase represents the Fed's intent to control inflationary pressures in the markets.

Although the Federal Funds Rate is not directly tied to mortgage interest rates, it does impact credit card borrowing rates and interest rates on Home Equity Lines of Credit (HELOC).

These rates have increased by 2.000% since the FOMC began its tightening on the economy 12 months ago. During this time, banks and credit cards companies have touted Prime Rate as extraordinary and encouraged customers to move high-interest credit card and other debt to Prime-based instruments.

You can't walk more than a few blocks without seeing a local bank advertising its rates.

For customers that have taken HELOCs, their cost of borrowing has increased and they may not be aware of it.

For example, in June 2004, a person financed a $150,000 home improvement project using a HELOC may have been quoted a very favorable rate of "Prime". That means that the customer has terrific credit, ample income and is generally considered to be low-risk to the bank.

The customer's rate -- one year ago -- was 4.000%.  The monthly payment on the $150,000 was $500.00.

But, after the FOMC raised the Fed Funds Rate, Prime Rate moved in kind. Prime Rate is now 6.000%. The customer's monthly payment is now $750.00.

That's a 50% increase.

The same effect can be found on credit cards where rates are tied to Prime Rate, too. Overall, our economy's cost of credit is increasing. Even the vaunted Capital One Prime Lock card is priced higher, but you all know how to handle your Capital One accounts now, don't you?

By contrast, mortgage rates remain low. Prime Rate is increasing, yet mortgage rates are staying flat.

This is defying market expectation and is creating a terrific opportunity for homeowners to take advantage of lower, fixed rates on mortgages by shifting their revolving, floating payments from HELOCs and credit cards to the home mortgage payment.

After Fed Raises The Fed Funds Rate, Mortgage Rates Come Down

The Fed raised rates again last week and have re-iterated their position on future Federal Funds Rate increases. With an extra 25 bps added to the rate after each of the subsequent three meeting, the Fed Funds rate will stand at 3.25%. That is a June 2005 target.

For people carrying Prime Rate-based interest, just add 3.

Therefore, a Prime Rate HELOC will be at 6.25% in June 2005.

Not surprisingly, mortgage rates have remained relatively flat. For many homeowners, this represents a terrific opportunity to refinance from a higher short-term cost of borrower to a longer-term fixed rate of borrowing.

In addition, the spread between the 5-year ARM and 30-year Fixed products is shrinking, decreasing the risk of carrying the fixed product for many homeowners.