The Fed lowered the Fed Funds Rate by 0.500% to 3.000% yesterday.  The move was widely anticipated and so Wall Street’s reaction was muted.

Because it is tied to the Fed Funds Rate, Prime Rate also fell by 0.500% yesterday.  Holders of home equity lines of credit and credit card debt benefited from the change and will see lower interest costs in next month’s statements.

In the statement above — as explained by The Wall Street Journal — the Fed expresses concern about the housing and jobs markets, while noting that inflation is less of a worry.  This leaves the possibility of future Fed Funds Rate cuts open.

Source
Parsing the Fed Statement
The Wall Street Journal Online
January 30, 2008

http://online.wsj.com/public/resources/documents/info-fedparse0801b.html

When the Federal Open Market Committee adjourns from its two-day meeting today, it is widely expected to lower the Fed Funds Rate.

This does not mean that mortgage rates will fall.

In fact, using history as an indicator, we should expect mortgage rates to rise if the Fed Funds Rate falls.

Remember: The Fed Funds Rate is an overnight interest rate between banks; mortgage rates are long-term rates based on the bond market.  These are two very different animals.

The FOMC’s press release hits the wires at 2:15 P.M. ET.

If you only read headlines this past week, you may have missed two very important points.

The first story relates to Housing Starts.  Housing Starts measure the number of new homes entering the construction phase.  The headline blared “Housing starts plunge to 16-year low“.

If you are a homeowner, this is terrific news. 

Because home values are governed by Supply and Demand, fewer homes built means that home demand has a chance to rebalance against home supply. 

This places upward pressure on home prices nationwide.

When Housing Starts drop, it says more about weakness in builder sentiment that it does about the state of the housing nationwide.  Housing Starts are at all-time lows because builders want to sell the product they have before putting more product on the market.

The second story was yesterday’s New Home Sales figures.

The headline read that “US new-home sales slide in record plunge” but, again, let’s look a little deeper.

New Home Sales are defined as homes that are newly built.  Stated differently, it specifically counts the number of homes sold that were once classified as “Housing Starts”.

If Housing Starts falls, therefore, we can expect New Home Sales to fall, too.  The two data points count the same housing inventory at two different points along a timeline.

These two stories are related but neither should be construed as bad news.  As builders cut back on the supply of homes, it should create an increase in relative demand.

For homeowners, this is a positive development.

(Image courtesy: New York Times)

Mortgage rates change from day-to-day, but last week’s volatility was a record-breaker. 

After drooping through Tuesday and then skyrocketing Wednesday and Thursday, mortgage rates retreated slightly on Friday. 

By weeks’ end, rates were at their same levels from mid-December.

This is in contrast to Tuesday, just after the Fed’s rate cut and before the stock market rally.  Mortgage rates had been touching near four-year lows for some home loan products.

This week could be equally hectic because heavy economic data it hitting the wires, and because the Federal Open Market Committee is meeting.

The major activity gets started Tuesday with the Consumer Confidence report. 

Markets care about this survey because recessions tend to be self-fulfilling prophecies — if people believe it will happen, it generally does.  Therefore, if average Americans are feeling worse about the economy, it may cause stocks to sell-off to the benefit of mortgage rates. 

Notice from the graph above how confidence plunged through the second half of last year.

On Wednesday, the FOMC adjourns from its two-day meeting. 

What the Fed does will not be as important as what the Fed says.  Markets will dissect the FOMC’s press release for clues about our economy’s strength.  If the statement cautions about dramatic weakness in the economy, expect mortgage rates to fall on the absence of inflation.

Then, on Thursday, markets get treated to the Personal Consumption Expenditures report.  The PCE is a Cost of Living index and is the Federal Reserve’s favored inflationary report.  If “normal living expenses” are increasing, it should create upward pressure on mortgage rates.

And lastly, on Friday, the Bureau of Labor Statistics releases the jobs report for January. 

Markets are expecting an improvement on December’s figure and if that adjustment is greater than expected, mortgage rates will rise on the belief that the economy is not as weak as previously reported.

It will be a busy week like last week so it pays to think in terms of “payment” instead of “rate”.  If you’re in the market for a mortgage and your proposed payment is within budget, consider locking in advance of this data-laden week.

(Image courtesy: The Wall Street Journal Online)

(Pronounced: NEGH-ah-tive am-ohr-tih-ZAY-shun)

Negative amortization is the process by which a loan’s principal balance increases on a month-over-month basis. 

This is in contrast to a “typical” amortization schedule in which the principal balance decreases.

Negative amortization is an optional feature on some home loans. 

These mortgages are usually referred to by the brand names “Option ARM”, “Pick-a-Payment”, or “Payment Option ARM”. 

Many industry veterans collectively call refer to these types of mortgages as “Neg-Am” loans.

When a Neg-Am mortgage statement arrives each month, the homeowner can choose his preferred payment structure. 

1. Pay the minimum balance due only
2. Pay the interest due only
3. Pay the principal + interest payment on a 30-year amortization schedule
4. Pay the principal + interest payment on a 15-year amortization schedule

Choice #1 is like making a “minimum payment” on a credit card. It is the only option that adds to the principal balance so, therefore, it is the only negative amortization option of the four payment choices.

In this sense, negative amortization is a choice and not a certainty.

In the early 2000s, Neg-Am loans grew popular as home affordability products.  Many homeowners made the minimum payment each month and found that their mortgage balance had swelled. 

Some of these homeowners lost their homes.

Because of their complex structure and potentially devasting consequences, NegAm home loans have been dubbed “nightmares” by several media publications. 

However, many sophisticated homeowners have successfully applied NegAm loans to help meet their financial goals.

Like all home loans, NegAm products are a better fit for some homeowners than others.  Some likely candidates include:

• 100%-commissioned salesperson who want better control over tax deductions
• Owners of multiple investment properties who want better control over cash flow
• Investors who seek leverage in real estate and who clearly understand market risk

Homeowners with questions about negative amortization loans should seek counsel from a qualified mortgage professional.

The Dow Jones Industrial Average surged 631.86 points in the last three hours of trading yesterday as traders piled into equities.

Fueling the rally?  The bond market. 

For as much as stocks gained today, bonds lost.  Including mortgage bonds.  The dramatic sell-off created a huge swing in mortgage rates and erased nearly all of 2008’s rate improvements.

This is one reason why it pays to be aware of your home loan.  That way, when markets change and a doorway to payment reduction opens, you can quickly step through it. 

As yesterday illustrated, with mortgage rates, opportunity is often fleeting.

With stocks poised to rise again today, it should likely happen at the expense of bonds.  Mortgage rates are trending higher, too.

(Image courtesy: The Wall Street Journal Online)

When the Federal Reserve lowered the Fed Funds Rate by 0.75% yesterday, it was in response to economic weakness that mounted since its last meeting December 11, 2007.

By contrast, the mortgage markets meet every day. 

Because of this, mortgage rates had already “priced in” the weakness to which the Fed was reacting. 

This is why mortgage rates did not fall by the same 0.75% yesterday — they only fell slightly.

Two important rates that did fall, though, were the 6-month LIBOR and the 1-year constant maturity treasury (CMT). 

These are two popular interest rates used in adjustable-rate mortgages.

When an ARM adjusts, it adjusts according to a simple math formula:

(New Interest Rate) = (Index) + (Margin)

Where:

Index: A variable, usually 6-month LIBOR or the 1-year CMT.
Margin: A constant, usually ranging from 1.500% to 6.999%

So, if the indices move lower — as we saw yesterday — the adjusted interest rate on a mortgage is going be lower, too.

As an example, LIBOR fell  percentage point over the last month from 4.83% to 3.83%.  This means that mortgage rates tied to LIBOR will adjust 1 percent lower than they would have in December 2007.

For every $100,000 in a principal + interest loan, this yields $65 per month in savings.

Of course, each mortgage has unique index, margin and rate characteristics so talk to your loan officer about how your ARM operates.

As promised, last week was heavy on data and on drama.  And mortgage rates continued their slide lower. 

This week, by contrast, is devoid of data and markets are already digesting the Federal Reserve’s surprise 0.750% rate cut this morning. 

Mortgage rates are falling in response, but not because of what the Fed did as much as what the Fed implied by doing it.

The Federal Reserve does not control mortgage rates, per se, but it does exert an influence.  This is because when the Federal Open Market Committee makes changes to the Fed Funds Rate, it is making a broader statement about the health of the economy.

This morning, and in advance of its 2-day meeting January 29-30, the Federal Reserve chopped the Fed Funds Rate by 75 basis points to 3.500%.  This signals to markets that the Federal Reserve is keen on engineering a soft landing for the economy.

Mortgage rates are falling for a different reason. 

The chart above is from last week and illustrates what traders thought the Fed would do to the Fed Funds Rate at its January meeting.

Note that over a two-month span, the market expectation changed.  The blue line (4.250%) represents the Fed Funds Rate prior to this morning.

Two months ago, markets overwhelmingly expected the FOMC to lower the Fed Funds Rate by 0.250% at its January get-together(as represented by the white line). 

As time passed, however, that expectation changed and mortgage rates changed, too.  This is not a correlated event, however.  Both the Fed Funds Rate and mortgage rates tend to fall during times of economic weakness.

On the right of the chart is last Friday.  At that time, market expectations for the January meeting were equally split between a 0.500% drop and a 0.750% drop (as represented by the orange and red lines, respectively).

The 0.500% drop signals weakness; the 0.750% signals dramatic weakness.

So, after the Federal Reserve’s surprise move this morning, it turns out that the Fed sees dramatic weakness.  Mortgage markets are reacting to this “news” and resetting their bets by buying more mortgage bonds.

This added demand is causing rates to fall, but not anywhere near the three-quarter percent levels by which the Fed cut the Fed Funds Rate. 

Mortgage rates are down slightly.

(Image courtesy: Federal Reserve Bank of Cleveland)

Overall, mortgage rates are at their lowest levels since late-2005.

Despite rates falling, however, not everyone can take advantage.

This is because mortgage lenders started to tighten the guidelines of what they will lend and to whom, also beginning in late-2005.

In other words, the chart at left doesn’t apply to all homeowners equally.

If you are new in your home, or have refinanced your mortgage within the last 24 months, make a call or send an email your loan officer to ask about today’s low-interest-rate environment.

(Source: Bankrate.com)

On average, Americans are now paying more than $3.00 per gallon for gasoline. This is roughly 40 percent higher than the cost of gasoline last January when gas hovered near $2.15 per gallon.

Higher gas prices are one reason why the economy is slowing down. With so many additional dollars being spent at the pump, there’s less money for discretionary items.

But, it could be worse.

The 5-year chart above shows how gas prices are failing to keep pace with rising oil costs. From 2003-2005, the correlation was fairly strong; starting in mid-2007, it’s been fairly weak.

If gas prices had been keeping pace with oil prices since last summer, Americans may have been subject to prices upwards of $5.00 per gallon nationwide.

(Image courtesy: GasBuddy.com)