The problem is, the Fed lowering rates to 0% does not mean you get loans at 0%.
This leaves us wondering, what does this news mean?
The Federal Reserve loans money to banks. Not to you.
The Federal Reserve (Fed) does not directly engage with the public. They are a “central bank,” not a retail or direct to consumer financial institution. You can’t go to the Federal Reserve to get a loan or open a savings account. The Fed lends money to banks so banks can lend money to you. The flow of money looks like this:
Federal Reserve → Banks → You
When you see or hear the Fed lowered rates, this means they lowered the rate of interest they are charging banks. This gives banks access to cheaper money so they can turn around and offer lower interest and financial flexibility to you. Here is the big thing to understand: it costs money to operate a bank, and banks want to make money. They aren’t going to turn around and offer you the same interest rate they get from the Fed. If the Federal Reserve gives them a rate of 0%, they are likely going to give you a higher rate to account for profit and risk involved with the loan. Here is an example of what the flow of interest rates could look like to give you an idea of how the process works:
Federal Reserve lends at 0% → Bank needs to profit 1% → Your loan risk is evaluated at 2% = Interest Rate You pay is 3% (0 + 1 + 2 = 3)
Mortgage interest rates are not controlled by the Fed.
When people were asking me how they can get their 0% loan, the loan they asked about most was their mortgage loan. This makes sense–getting a lower rate on your mortgage could save you a lot of money. However, when the Fed lowers rates, it does not lower rates on mortgage loans.
As mentioned above, the Fed loans money to banks. But this is short term money. This money is being used for things like car loans, credit cards, and other short term lines of credit. This means when the Federal Reserve lowers rates it will likely result in lower rates on credit cards and auto loans, not mortgage home loans.
Mortgage loans don’t use money from the Federal Reserves. Mortgage loans use money from a bond called a Mortgage Backed Security.
PRO TIP: If you hear that the Fed lowered rates and you have an auto loan or a credit card – it may be a good time to inquire with your bank to see if they can offer you a lower rate on an auto loan refinance or credit card balance transfer.
One headline that WILL get you a lower mortgage interest rate.
Now that you know Federal Reserve rate cuts don’t impact mortgage interest rates, what headline can you look for to alert you about lower rates on home loans? This one:
“$200 Billion of Mortgage Backed Securities to be Purchased”
This is a recent headline that let me know mortgage interest rates will be going down. Because mortgage loans use money from Mortgage Backed Security bonds (MBS), mortgage interest rates will go down when more Mortgage Backed Securities are purchased. The flow of mortgage interest rates looks like this:
Lots of MBS purchases → More money available for mortgage loans → Lower mortgage rates
Although the Fed cutting rates does not cut mortgage rates, the Fed can still take action to lower mortgage interest rates. They can use money available to purchase Mortgage Backed Securities. This practice is often used during turbulent economic times. Because of the uncertainty in our economy surrounding the Coronavirus, the government has decided to earmark $200 billion of Federal Reserve money for future MBS purchases. Again, this will lower mortgage interest rates.
But the $200 billion won’t be flooded into the Mortgage Backed Security market all at once. The Fed will slowly buy MBS as part of a process that will take years. They will monitor mortgage interest rates and buy MBS to bring mortgage interest down over time.
PRO TIP: Rates won’t go down right away–it’s a process. A wise action you can take is connecting with your local mortgage broker now. Communicate to them what rate you currently have and let them tell you what rates should be for it to make sense to refinance. This way, your mortgage broker can monitor rates for you and work together with you if/when the time comes.
What does it mean when the Fed cuts rates?
- It means the Fed has lowered rates on money they loan to banks.
- This will result in lower rates available on short term loans like car loans and credit cards.
- This does NOT lower rates on long term loans like mortgages.
If you are interested in taking advantage of the low mortgage rates coming as a result of the Fed buying Mortgage Backed Securities, schedule a phone call with one of our Home Loan Advisors below. They will monitor rates for you and let you know when it’s a good time to move forward with a refinance.