Fed rate cuts help people who hold adjustable rate mortgages (ARMs) but they're less valuable to people seeking new mortgages.
That's because ARM rates reset periodically -- e.g., every year -- based on an index plus a lender's margin -- the amount a lender adds to the index, usually two percentage points or four percentage points, to set the actual interest rate of the ARM. The most common index for ARM adjustments is the one-year U.S. Treasury bill.
Last Friday, the one year treasury rate was at 1.88% -- down 3.04 percentage points below the 4.92% rate it was at in April 2007. The Fed's rate cutting has lowered the rates at the reset periods for those who already have adjustable rate mortgages. So a person who paid 2% plus the 1-year t-bill rate in April 2007 would have paid 6.92% during the last year and enjoyed a reset to 3.88% as of last week.
But the 5/1 ARM which currently averages at 5.58% was 5.91% in April 2007. This suggests that the Fed's interest rate cuts have not had that much of an effect on mortgage rates for those seeking a new mortgage. The Fed's rate cutting will continue to help people depending on what rate they are paying now and what the one year T-bill rate is at the next reset.
But many expect the Fed to stop cutting rates effective today for some time unless there is another market crisis along the lines of the collapse of The Bear Stearns Companies (NYSE: BSC). If rates are the same a year from now, obviously those people whose rates adjusted today will pay the same rate from April 2009 to the next adjustment period.
Who knows what the Fed will do next? It doesn't have much more room to cut rates but I have no doubt that in the event of another capital markets crisis it will slash rates again and flood the market with more liquidity. This pattern will continue until January 2009 at which point the trajectory will depend on who occupies the White House.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in Bear Stearns securities.
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Reader Comments (Page 1 of 1)
4-30-2008 @ 6:37PM
william lindblad said...
The ARM holders received a TEMPORARY rate cut. Ben & co made their last stand today and the best that anyone could hope to get from the Fed for the next few months is - static. If the inflation pressures continue they are more likely to into a rasing cycle. Anyone that is on moving round with an ARM mortgage would be wise to look into conversion to a fixed rate. If one can not afford the current fixed the alternative is to sell or go into default by this time next year.
As far as a pattern - same until Nov. After that it is anyone's guess. For the present I expect oil/gas to stabilize, but at high levels and the housing inventory to peak in late July/early August. So will price bottom - and it will stay for a long time.
4-30-2008 @ 8:25PM
RICH BRULATO said...
I agree that a rate cut doesn't do much for those who are looking to refinance to a fixed rate mortgage.
4-30-2008 @ 10:28PM
Bobby said...
The lending institutions are the ones that profit greatly from the lowering of rates by the feds. Each tier of the almighty buck gets chiseled away as it finds its way to the consumer of which the cuts are supposed to help the most. I'm tied into a 7 figure note attached to prime with a half % markup with the catch phrase in my contract of a 7% floor. I wasn't in a position to squabble over the terms when i signed on but with my history with the bank thought it would be easy to renegotiate if the rates dropped substantially. Now the bank tells me their "cost of funds" won't allow them to pass on the savings to me. I haven't discussed it with an atty. yet but i'm of the opinion this borders on unfair business practice. For what it's worth to all who are listening, never put your complete faith in the handshake or supposed integrity of a lender. In the end, it's primarily their survival over yours, even if there's isn't in jeopardy....
5-01-2008 @ 6:23AM
al coholic said...
William Lindblad....
Do you have your own blog? I read a lot of your comments and fine them to be at least as informative as the blogs you respond to.
Since the most dangerous part of this crisis lies with the people who are on the brink of default with ARM's it seems to me that the Fed's focus is where it should be.
The Fed knows we will suffer a lot of inflation down the road to pay for this. Apparently they have chosen what they consider to be the best of two evils.
5-01-2008 @ 7:01AM
John said...
Have an attorney look at what?!?!?!? Did you not read what you signed? You do not have a case. It is clearly stated what the floor of the loan is. That is clearly your responsibility to read that. If you didn't like the terms, you should not have bought the house or refinanced it. Clear and simple. No excuses.