| Q:
When the Fed lowers the fed funds rate, why doesn't the
rate the banks charge go down the same amount? What other
factors affect the interest rate for a home loan?
A: A change in the
federal funds rate usually results in banks immediately
changing their prime lending rate by a like amount. The
federal funds rate is the interest rate banks charge each
other to borrow banking reserves held at the Fed. You can
view it as a bank's marginal cost of funds.
Thirty-year fixed-rate mortgages aren't going to be priced
off federal funds, which is an overnight lending rate between
banks. Trends in the yield of the 10-year Treasury note
are a much better predictor of where interest rates are
going in the fixed-rate mortgage market. At this writing,
the 10-year Treasury note is yielding 4.95 percent. Time
may prove me wrong, but I don't think there's a whole lot
of room for the 10-year note's yield to reach much lower
yields over the next six months.
Credit risk and collateral (down payment) are two of the
major determinants of mortgage interest rates influenced
by the consumer. The interest rate on a mortgage has to
be high enough above the Treasury rate to compensate mortgage
investors for the increased risks associated with investing
in mortgages.
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The Fed funds rate (FFR), the overnight lending rate between
banks, is a money market rate that the Fed steers towards
its target through its control of excess reserves. Banks
typically raise the rate at which they lend money to their
best customers -- their prime rate -- after the Fed raises
the overnight lending rate.
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