Fed's interest-rate cuts will benefit ARM, HELOC borrowers
Effect on long-term rates remains to be seen

Tuesday, January 22, 2008

By Matt Carter
Inman News

The unscheduled and dramatic cut in short-term interest rates announced today by the Federal Reserve will provide immediate relief for borrowers with home-equity loans or facing interest-rate resets, mortgage market experts say.

But long-term rates -- which were at 2 1/2-year lows before today's 75-basis-point reduction in the discount rate and the target for the federal funds overnight rate -- could move in the other direction if bond market investors get nervous about inflation.

For now, the Fed seems to have decided that the threat of a recession far outweighs the risk of inflation, making in a single day cuts in short-term rates some observers had expected would be stretched out over months.

"Just a few weeks ago, the consensus was that the Fed would cut no more than 75 basis points, and 3.25 percent would be trough," said Freddie Mac's chief economist Frank Nothaft. "We're there already. So are we at the low point? It's really hard to say."

Nothaft said the Federal Reserve's Open Market Committee could cut rates again when it holds its scheduled meeting Jan. 29-30. Or its members may want to wait and see how to today's dramatic move affects economic indicators.

The rate cuts are "certainly good news for people who have mortgages, or are shopping for a mortgage," Nothaft said. For those with adjustable-rate mortgages (ARMs) indexed to the prime rate or home-equity lines of credit (HELOC) loans, "this shows up right away in terms of lower interest rates," as banks follow suit and lower the prime rate to 6.5 percent. For ARM borrowers facing interest-rate resets, Nothaft said, that translates into a smaller increase in payments, and "maybe even a decline."

According to Freddie Mac's most recent weekly survey of mortgage rates (see Inman News story), the 5.69 percent rate on a 30-year fixed-rate loan was the best in 2 1/2 years. While it remains to be seen what effect the cut in short-term rates will have in the long run, rates on 10-year Treasurys fell today as stocks bounced back from earlier losses, Nothaft said.

Although rates on 10-year Treasurys are not linked directly to mortgage rates, they tend to move in the same direction, as they play a similar role in investor's portfolios.

"It helps more than it hurts," said Doug Duncan, the chief economist for the Mortgage Bankers Association. "It's probably not going to bring long rates down much further, but it certainly brings short rates down, and has some positives for the whole economy and housing."

Duncan said what happens with long-term rates depends largely on whether market participants think the Fed has gone far enough with short-term cuts.

If today's cuts are seen as adequate, "that increases expectations of future economic growth, and may establish a sort of bottom where the 10-year Treasury yield is going to go," Duncan said. "I don't expect the 10-year Treasury yield to go much (lower), unless there were a whole bunch more difficult financial announcements made in the next couple of months."

What the rate cuts probably won't do is restore investor confidence in the secondary market for mortgage loans not guaranteed by Freddie Mac and Fannie Mae. That means borrowers seeking subprime and so-called jumbo loans will continue to pay much higher rates than offered during the housing boom.

Although the secondary market for loans within the $417,000 conforming loan limit "is working just fine," Nothaft said, rates on jumbo loans are about a full percentage point higher than those for conforming loans.

The National Association of Realtors and some Democrats in Congress are pushing for a 50 percent increase in the conforming loan limit to allow Fannie and Freddie to buy or guarantee loans that are now considered "jumbo."

The Bush administration wants stricter oversight of Fannie and Freddie in place before it will go along with an increase in the conforming loan limit, saying the bigger loans may involve more risk, and reduce the number of smaller loans the government-sponsored enterprises can back (see story).

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