When the FED lowered the prime rate, why didn’t mortgage rates go down?

The Federal Reserve lowered the prime rate by .5 a point at their September 18th meeting. A major reason stated for lowering the prime rate was to prevent the mortgage market’s trouble from affecting the economy.

“…the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.”

Their major concern is to protect the broader economy, not necessarily to save the real estate market. As I mentioned in an earlier post, I didn’t think that lowering interest rates would bring any new buyers into the market. As it turns out, lowering the prime rate didn’t produce a similar lowering of mortgage interest rates anyway.

Mortgage interest rates are not tied to the prime rate. They are more influenced by the bond market and inflation. The graph below shows how the rates have moved mostly unrelated over the past three years.


The immediate effect of lowering the prime rate is a drop in your credit card and home equity lines of credit rates. The drop in prime did little to lower mortgage rates, but they are still historically low. Lowering prime may help boost consumer confidence and might bring investors back, but if you’re waiting for them to drop prime again to get a better rate before buying a home, you may be waiting in vain.

“Mortgage Meltdown” is an overstatement

Part of the reason I haven’t written an entry on this blog in some time is the glut of sensational articles in the media. With headlines that scream CRISIS, MELTDOWN, and FORECLOSURE it is hard to get to the meat of the issue. Many potential buyers think that they can not get financing. This is not true for most borrowers.

First a little flowchart of how money is lent out. The mortgage broker or bank approves a loan for a home buyer. Rather than keep the loan and wait for the monthly payments, that loan is likely sold by the bank in order to get more funds to loan out. The way these loans are sold is by bundling many loans together and selling them as mortgage-backed securities on the bond market. Investors buy the securities and get a rate of return based on the types of loans in the security. The bank gets the needed cash to lend; the investors get a regular return.

The mortgage market’s problems stem from the past few years of easy lending requirements. The investors were all too eager to buy the mortgage-backed securities, not accounting that there was some risk attached to them. As the investors were buying without analyzing risk, some lenders (particularly sub-prime) stopped looking over borrower’s documentation. Borrowers were getting approved for more money than they could afford. Some borrowers never should have qualified at all. The lenders are to blame for not qualifying the borrowers; the borrowers are to blame for not realistically judging their ability to pay, and the investors are to blame for not balancing the return on investment vs. the risk.

Some loans started going bad --> Investors stopped buying the mortgage-backed securities --> Funds for new loans dried up --> Many lenders have gone out of business.

The remaining lenders have tightened their guidelines, partially to reduce the risk of foreclosure, but mostly in hopes of getting investors to start buying the loans again. This does mean that some borrowers no longer qualify, but many still do. The high loan-to-value and “no documentation” loans are largely gone, but the borrower that earns a paycheck and has a decent credit score can still get financing. 100% financing is still available as well, and mortgage insurance (if needed) is deductible just like interest on your loan. Rates are still at historical lows. This is actually a great time to be a buyer with low interest rates, a large supply of homes for sale, and employment still strong in the area.

Some sanity has returned to the lending industry. Lenders are back to qualifying borrowers based on their documentation. The highest risk borrowers will not qualify. It may be a while before the panic of the investors subsides, but for many borrowers not much has changed.

A long walk to the bathroom

The city of Bothell has a population of about 31,000 residents, and it covers roughly 12 square miles. The odd thing about Bothell is that roughly half of the land area is in King County, the other half in Snohomish County.

A new condominium complex adds to this confusion. The county line splits the complex so that thirteen of the buildings are in Snohomish County and three in King County. Worse yet there is one building that actually straddles the line. This means that a home’s bedroom might be in a different county than the bathroom. I imagine the permit process for this building was a nightmare.

I wonder if they will get a property assessment from each county. Will the King County half be worth more than the Snohomish County half?