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December 16, 2008 08:09 PM
What impact will this have on mortgage rates?
With regard to the Federal Reserve chairman lowering the benchmark rate to a range of 0 to 0.25 percent.
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| December 16, 2008 11:07 PM |
That is only the ultra short term rates. Fed funds is a one day rate and the discount rate is usually 30 days or less. Neither of these rates has ANY effect on consumer rates outside of a college textbook. There is a significant stigma involved in "going to the window" ( borrowing from the fed discount window ) thus that rate is almost never used by real banks.
Mortgage rates are determined by long term treasury rates vs the willingness of investors to buy the mortgages vs the number of people lining up for the money ( supply and demand )
When the fed starts actually buying the mortgage paper they are promising to buy ( but as yet have not actually done so ) that will drive up the market price of mortgage paper. Due to the inverse relationship between the price and the yield of fixed income investments, driving up the price of mortgages will reduce the market yield on mortgages.
It works like this:
( Highly oversimplified )
Assume I buy a 100,000 mortgage with a 5% rate
if I pay $100,000, my rate of return is 5.00%
if I pay $105,000, my rate of return is 4.76 (5000/105000)
if I pay $ 95,000, My rate of return is 5.26% (5000 / 95,000)
By buying enough mortgages and raising the market value of mortgages, the Fed can theoretically lower the mortgage rate to any level they desire.
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• thanks! very helpfu!
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Other Answers (1)
December 16, 2008 08:21 PM
There are two main impacts. One is that banks will be able to borrow money for almost nothing. When they pay back, they will pay back almost exactly the same amount. The second is that next time the Fed chairman needs to do something quick to spur the economy on, he won't be able to lower any interest rates because it's already at 0. So he's run out of options and that's never good news.
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