The Federal Reserve Has Swooped In to Save Mortgage Rates

Last updated on March 24th, 2020
The Federal Reserve Has Swooped In to Save Mortgage Rates

In light of the ongoing coronavirus outbreak, which were the Federal Reserve’s very own words, the Committee took bold action to lower the target range for the federal funds rate to 0% to 0.25%.

That’s a full percentage point lower than the 1% to 1.25% it had been previously. And comes on top of the half-point cut executed just over two weeks ago.

As such, the prime rate has fallen from 4.75% to 3.25%. The prime rate directly affects consumers via things like credit card interest rates and home equity lines of credit (HELOC)s because they’re typically tied to that index.

For homeowners with HELOCs, their interest rates will adjust down 1.50%, which will provide meaningful monthly payment relief.

But what about first-lien mortgage rates, which hit record lows a couple weeks ago, then shot back higher once the market was flooded with mortgage-backed securities (MBS).

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Well, the Fed also addressed that issue by effectively starting a new round of quantitative easing, which will probably be known as “QE4.”

Fed Pledges to Buy Agency MBS to Lower Mortgage Rates (QE4)

  • Fed said coronavirus outbreak has hurt communities and disrupted economic activity in the United States
  • To promote maximum employment and price stability it has lowered federal funds rate to 0% to 0.25% range
  • Also announced it will increase its holdings of Treasury securities by at least $500 billion and holdings of agency mortgage-backed securities by at least $200 billion
  • This will lead to lower mortgage rates for homeowners

The federal funds rate doesn’t directly affect consumer mortgage rates, you aren’t getting a 0% mortgage rate.

However, the Fed’s emergency announcement to buy agency MBS does.

First, here’s what they’re doing to combat a recession and ease global markets:

“To support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses, over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion,” the FOMC statement read.

“The Committee will also reinvest all principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.

In short, the Fed has come to the rescue of the mortgage market, which didn’t seem like it needed rescuing until excessive mortgage demand worked against consumers.

Because there was a flood of mortgage applications, and not enough demand from investors of mortgage-backed securities, lenders were basically forced to raise mortgage rates to limit supply.

But now that the Fed has pledged to purchase at least $200 billion in agency MBS, and reinvest payments into agency MBS, lenders shouldn’t have trouble fetching a higher price for the home loans they sell.

As such, they’ll be able to decrease mortgage rates and perhaps we’ll see those record lows again.

How Low Will Mortgage Rates Go with QE4 in Place?

  • 30-year fixed mortgage rates were averaging around 3.75%-4% before the news hit
  • When the Fed launched QE3 in September 2012 it led to record low mortgage rates
  • At that time the 30-year fixed fell from around 3.55% to 3.31%
  • Expect mortgage rates to return to the low 3s and perhaps to new all-time lows over time

So we know mortgage lenders (and homeowners) are going to see some relief from QE4. The next logical question is how much will mortgage rates actually fall.

As noted, interest rates were suppressed by an oversupply, but now that a whale of a buyer has pledged to buy hundreds of billions in MBS, we should see interest rates fall again.

That’s great news for consumers, namely those looking to refinance mortgages or purchase a new home.

The bad news is mortgage rates jumped more than half a percentage point last week as a result of the oversupply, and thus might not hit those all-time lows again. And even if they do, it could take some time to do so.

When the Fed launched QE3 back in September 2012, the 30-year fixed averaged roughly 3.55%. During the weeks and months that followed, rates fell about 25 basis points.

In fact, the prior record low for the 30-year fixed was 3.31%, recorded during the week ended November 21st, 2012.

We’re in similar territory now, with mortgage rates pretty close to those September 2012 levels.

So we might see rates move in familiar fashion, from around 3.75% to 3.375% and on down to 3.25% if all goes according to plan.

Whether they hit 3% or even dip into the high 2s remains to be seen, but given the Fed’s pledge to buy billions in MBS, coupled with the 10-year bond yield below 1%, it’s certainly possible.

I just wouldn’t expect lenders to go too crazy in lowering rates at the moment, given they still have a ton of demand and lots of applications in their pipelines to process.

Still, it’s huge news because it means lenders have certainty now to originate ultra-cheap mortgages without fear of being stuck holding the bag.

But it might take some time for rates to trickle down and reach record lows again. Again, hang tight here, as I mentioned before.

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