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Interest Rate Predictions

The American financial system is under pressure. The Fed is lowering interest rates, yet mortgage interest rate predictions are still rising – how can this be? And what does it mean for home owners? The first important concept home owners need to understand about interest rate predictions is the relationship between the interest rates set by the Fed and the interest rates charged by mortgage lenders.

Interest rates set by the Fed affect the cost of funds to mortgage lenders. Banks and other lenders don't have all the fund they lend out as mortgages – they actually borrow 90% of what they lend out to home owners on the wholesale market at interest rates lower than the rates they charge home owners on their mortgages.

When the Fed lowers interest rates, it lowers the costs to mortgage lenders, so you would think that interest rate predictions would fall. However, mortgage lenders may choose not to pass on their savings to home owners.

The reason is not greed – there is enough competition in the mortgage market to ensure that no lender can profit unfairly. The reason is that being a mortgage lender just became a whole lot more risky, and risk raises interest rates.

Lenders are charging everyone more interest to cover their losses on the few who will default on their mortgages. Until the housing market stabilises, default risk will remain high, and interest rate predictions will remain high.

There is a limit to how much the Fed can lower interest rates, too. The actual interest rate (called the "nominal" rate) includes inflation. To find the "real" interest rate, you need to subtract the inflation rate from the nominal interest rate.

The thing is, when you do that just now, the result is a negative number! Nominal interest rates are not even high enough to keep pace with inflation.

Obviously, this is a situation that simply cannot continue for very long. The Fed will have to raise interest rates to at least break-even levels, matching the rate of inflation. This interest rate rise will definitely flow through in to mortgage interest rates.

In other words, it's really only a matter of time, and not much time, before mortgage interest rates rise again.


Source by Mark Bennett


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