Vail Daily column: Here today, gone tomorrow
On Sept. 17, Federal Reserve Chairwomen Janet Yellen announced that the Federal Reserve Board would leave the short-term lending rate or the Federal Funds rate unchanged and at a whopping 0.25 percent. Thank goodness?! Or wait, is this actually bad news? What exactly the Federal Reserve Board does and what the Federal Funds rate is can be confusing and really unknown.
Since December of 2008, the Fed Funds interest rate has been at nearly 0 percent, or 0.25 percent to be exact. The Federal Open Market Committee, chaired by Yellen sets the rate. In recent speeches, Yellen and other Federal Reserve Board members have indicated that the rate will most likely increase sooner than later. Economists and business people alike thought that the first rate increase in over seven years may have come two weeks ago, but to no avail. But what does this mean for the average consumer and especially the average consumer with a residential real estate mortgage?
BANKS LENDING TO BANKS
For starters, the “Fed Funds Interest Rate,” which is currently at 0.25 percent, is not an interest rate that is available to any consumer. Twenty five basis points or 0.25 percent is the rate at which banks lend each other money on a very short-term basis. By short term I mean overnight. Regulations require that all banks and lenders keep a certain amount of cash reserves on their balance sheets at the close of every business day to off-set their debt or “balance” their financials.
At the end of any business day, if a particular bank does not have the required amount of reserves in their bank, then the bank or lending institution must borrow the necessary funds from another bank or directly from the Federal Reserve Board. Said money is borrowed generally just overnight at the pre-determined Fed Funds interest rate. Such a process is much more in depth and involved than my explanation, but that explanation can suffice here.
PRIME INTEREST RATE
While a borrowing rate of 0.25 percent is not available to consumers, the prime interest rate is. The more common and advertised prime lending rate generally set 300 basis points or 3 percent above the Federal Funds rate, making the current prime lending rate 3.25 percent. Prime lending rates are more applicable to consumers as this is the base rate most are offered on car loans, student loans and home equity lines of credit. So the good news is that debts like this will remain based off of a rate of 3.25 percent for the time being.
Pertaining to mortgages, the Fed Funds rate does certainly play a role in mortgage interest rates, but not as much so as most might think. When adjustable rate mortgages (ARMs) begin to adjust after their initial fixed period, the rate of adjustment is based upon a margin or mark-up from the lender added to a current index such as the U.S. Treasury index or the one-year LIBOR index. These indices tend to increase and decrease as does the Fed Funds rate. When the Fed Funds rate is “low,” the referenced indices generally are as well. Therefore, those borrowers who currently have ARMs that are adjusting are probably adjusting currently down to rates in the low 3 percent range.
MORTGAGE RATE FACTORS
Past adjusting ARMs, the Federal Funds interest rate play a very small role in determining long-term mortgage rates. Mortgage rates are not dependent upon or derived from the U.S. prime lending rate nor the Federal Funds rate set forth by Yellen and company. Mortgage interest rates are dependent and fluctuate upon factors both national and global such as inflationary levels, employment numbers, foreign purchasing of U.S. debt just to reference a couple of the many factors influencing long term interest rates.
While interest rates across the board are low right now, it is important to understand that mortgage interest rates cannot be set at or held to one particular level or rate. Economic factors on a global scale which tends to be quite erratic and unpredictable have more of an influence on mortgage rates. Mortgage rates advertised or available today could quickly be gone tomorrow.
William A. DesPortes, of Central Rockies Mortgage Corp., can be reached at 970-845-7000, ext. 103, and email@example.com.