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The Federal Reserve And Refinancing

Apr 13, 2008
Does the recent lowering of interest rates by the Federal Reserve affect refinancing options? Here are the basics and a few key points to keep in mind:

1. In light of the recent financial turbulence that resulted from sub-prime mortgage lending, the Federal Open Market Committee (FOMC, or Fed) reduced the Fed Funds Rate. The Fed Funds Rate is considered a short-term rate and represents the interest rate at which large banks lend to each other. The Federal Reserve cut its target for the rate in order to provide a counterbalance to the tightening of credit conditions and to address some of the risks that financial conditions pose to the broader economy.

2. Short-term interest rates such as those on adjustable rate mortgages, credit cards, and home equity lines of credit can be affected by the Fed Funds Rate. When the Federal Reserve enters a rate-cutting period such as we are in now, the prevailing rates may become significantly lower than the rates that existed during the original purchase of a home. By refinancing a mortgage when interest rates are lower, a homeowner can exchange a higher interest rate for a lower one, in turn lowering monthly payments.

3. Unfortunately, many homeowners with adjustable interest rates on a sub-prime mortgage fell behind on payments when their rates reset to significantly higher levels. Avoiding the payment shock of an interest rate reset by refinancing is increasingly difficult as home prices have leveled out or declined, reducing homeowners' equity. In response, the Federal Reserve and other banking agencies issued statements calling on mortgage lenders to pursue prudent loan workouts.

4. The stock market responds to indications that the economy might be slowing. In turn, mortgage interest rates are responsive to daily market activity and may fall in response to a lowering of Federal Reserve rates. Mortgage rates have begun to rise as bond traders begin to fear rising prices that could result from monetary and fiscal stimulus.

5. Although it remains to be seen if those seeking new home mortgages will benefit from the Fed's latest cut, the decision, combined with planned government spending and proposed expanded limits on federally insured home loans, will hopefully help stabilize the housing market by providing the liquidity needed to bring consumers back into the market.

6. Thirty-year fixed-rate mortgages have been dropping since December 2007 with a current average of 5.5%, low by historical standards. Now is an excellent time for homeowners with an adjustable rate mortgage that's going to reset to swap into a fixed-rate loan. People currently in the best position to get mortgages have good credit, proof of income, and either money for a down payment or equity in an existing house.

Experts often advise against refinancing unless the new rate is at least two percentage points lower than the rate a homeowner is currently paying. Additionally, if a homeowner does not plan to stay in the house very long, the benefits of the lower rate may not last long enough to justify the costs of refinancing. However, the unprecedented Federal Reserve rate cut on January 22 is an indication that the Federal Reserve Chairman, Ben Bernanke, is serious about the problems facing the credit market, leaving the door open to further rate cuts if risks remain.
About the Author
There are many reasons to refinance your mortgage. You may need lower repayments or maybe you can obtain a lower interest rate. Whatever the reason it's a good idea to get educated on refinancing before taking action. Get mortgage refinancing education here.
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