Any time the Federal Reserve changes the federal funds rate, people start making predictions about how it will affect the markets. In September, the Fed raised rates by a quarter point, moving the target from 3.75% to 4.00%. So the question for those in the real estate market is: should we expect mortgage rates to rise? In this case, probably not much more than they already have.
As with any complex system, everything is related, but it can sometimes be hard to tell what actually drives the system.
The federal funds rate is the overnight interbank lending rate set by the Fed—what banks charge one another for reserve-balance loans. The discount rate is the rate banks pay when borrowing directly from the Federal Reserve, and the prime rate is the rate banks offer their most creditworthy borrowers. These rates matter because they influence consumer and business borrowing costs.
The Fed most directly influences short-term rates; the shorter the term, the greater the Fed's impact. So, for example, lines of credit are highly sensitive to Fed rate changes. They are usually adjustable rate loans with interest rates that can change with market fluctuations. At the opposite end of the spectrum are 30-year, fixed-rate home loans. Car loans are somewhere in the middle.
The Fed’s job is to promote maximum employment and keep prices stable, and it uses monetary policy to do so—the discount rate being one of its favorite tools. Oftentimes, there’s a correlation between the discount rate and mortgage rates, because commercial banks pass on their costs to customers.
Here's what many people miss: it is financial markets that determine mortgage rates, not the Fed. Although the Fed is supposed to be apolitical, I think it’s fair to say the Fed feels some political pressure.
Virtually all presidential administrations love low interest rates because low rates make them look good, but if the Fed lowered the current discount rate dramatically, the marketplace would not believe that was the right action. In fact, financial markets would likely see the move as inflationary. Long-term interest rates are far more attuned to inflation than they are to the Federal Reserve discount rate. If the Fed lowered the discount rate in an attempt to control the market, it would fail. The worry over inflation would actually cause interest rates for 30-year, fixed-rate home loans to go up, not down.
So, with all this talk about rates, the question on people’s minds about real estate is: when is the best time to buy or sell? Keep in mind that while inflation has a direct impact on long-term mortgage rates, it also has a direct impact on the future value of any real estate. If you’re buying today and paying a high interest rate because inflation is high, the value of your property is also going up. One offsets the other. On the other side of the coin, if you postpone a purchase, then the rates may be lower but you’re likely to pay a higher price.
Ideally, you want to buy when prices are low because even if interest rates are high, you can refinance when interest rates drop, as much of the country did a few years ago. This is why so many people are holding mortgage loans at 2.5%. If the interest rate on your home loan is fixed and inflation drives the value of your house up, your monthly payments don’t go up and you’re a real winner. Historically, this is how it has worked for homeowners.
If you have questions about property management or real estate, please contact me at [email protected] or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.
Dick Selzer is a real estate broker who has been in the business for more than 50 years. The opinions expressed here are his and do not necessarily represent his affiliated organizations.
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