Gee, David, what are rates gonna do?

I have been asked that question more times than I can remember, having worked through four refinance booms over the past decade.

And the answer is "I don't know what they will be, but I can tell you where they've been and where they are now."

Anyone who claims to know what interest rates are going to do would be better spending time in Vegas with their prognostication powers. No one knows. But with the advent of a better educated consumer via television, radio or the Internet, suddenly we've gotten a new class of experts. But let's take a look at what drives interest rates, and what doesn't by examining three common statements.

"David, I'm going to wait until the 30-year Treasury Bond yield dips a little more".

The 30-year Treasury and mortgage rates have little correlation to mortgages, other than they're both fixed instruments. It's like comparing the price of Dell or IBM stock to the Dow Jones Industrial Average. Maybe you'll see some coincidental moves, but mortgages aren't tied to 30-year bonds.

There are several reasons, but one of the most significant concerns maturity. Most mortgages last around 7 years or so, and given wild interest rate swings and the ability to refinance with little or no cash cost up front, they could be even shorter.

Treasury Bonds last 30 years. A closer comparison would be to check the 10-year Treasury Note, it's maturity is closer to the average mortgage term, but again, this is not a foolproof benchmark.

"I'm going to wait until the Feds cut rates, then I'll lock."

This can often be too late. Lenders, as well as the stock markets in general, anticipate Fed movements rather than react to them. A few days ago, for example we were awaiting the results of the Fed meeting scheduled for March 20th. We anticipated a 50- or 75- basis point cut in rate, as we have since their last meetings. Suspecting how the Fed would move, lenders have priced mortgage rates over the past few weeks expecting such a cut.

People who manage money don't like surprises, so if the Fed's move follows what is expected, rates won't change. Instead lenders will be watching for economic signs of future Fed actions.

If lenders feel the economy is sufficiently stimulated and that no more rate cuts will be needed, then rates will begin to move back up. That's why, with the last rate cut in a series, mortgage rates are likely to rise.

"I thought the Feds dropped the rates by .5 percent, why haven't you dropped your rates by the same amount?"

Again, lenders anticipate Fed actions, they try not to react to them. But the Federal Reserve only cuts the Federal Funds Rate or the Discount Rate. But these are very short term rates, overnight ones for banks, and have nothing to do with fixed-rate mortgages. The Fed Funds rate -- the rate banks charge one another to borrow money -- is set by Greenspan and his buddies.

Why do banks borrow from one another overnight? Because banks have reserve requirements to meet at the end of the day; if they don't have enough cash in a reserve account compared to the amount of loans they have outstanding, they have to find the money....fast. They do that by borrowing money from each other. The rate on that overnight borrowing is what the Feds cut, not mortgage rates.

Fed movements are simply indicators for the long market (bonds, bills, mortgages) as to what they think the economy will be like in the near future. Rising rates tend to slow the economy while falling rates tend to stimulate it.

Mortgage rates are tied directly to mortgage-backed securities, generally called Fannie Maes or Ginny Maes. Lenders across the country steadily watch these indices daily and price their mortgage rates accordingly. Other factors -- such as market position and loan stimulus -- can affect mortgage pricing.

So there you have it. Mortgages are their own index, mortgage rates are not especially related to Treasury Bonds interest levels, and if you're waiting for the Feds to do anything, it may be too late. And if someone tells you they know where rates will be in the future -- regardless of their job title or past results -- it would be wise to be wary.

For more articles by David Reed, please press here.