Even if the Federal Reserve's quarter percent reduction in short term interest rates don't force mortgage interest rates lower, the cost of mortgage money is likely to get cheaper, if only for a while.

"I don't think we've seen the bottom yet," said Robert Van Order, chief economist for Freddie Mac.

In response to global economic troubles, the Fed on Sept. 29 lowered the benchmark federal funds rate, which banks charge each other on overnight loans, to 5.25 percent from 5.5 percent. The discount rate, the rate the Fed charges on its own loans to banks, remained untouched at 5 percent.

"The recent changes in the global economy and adjustments in U.S. financial markets mean that a slightly lower federal funds rate should now be consistent with keeping inflation low and sustaining economic growth going forward," said the Federal Reserve in a statement announcing the move.

The first reduction in the funds rate since January 1996, led BankAmerica Corp., Chase Manhattan Corp., NationsBank Corp. and other major U.S. banks on Sept. 30 to lower their prime rate (the rate they charge their best customers) to 8.25 percent. The prime rate had stood at 8.5 percent since March 25, 1997, the date the Fed last changed the federal funds rate.

Because the prime rate is the benchmark lenders use when making consumer loans, short term mortgage interest rates, those for equity loans and adjustable rate mortgages (ARMs), are most likely to slip.

Indeed, after the drop in the federal funds rate, one year ARMS fell to 5.49 percent, Sept. 30 and 5.47 percent, Oct. 1. according to Bank Rate Monitor. Equity loans, however, remained steady at 9.32 percent both days, as did home equity lines of credit (HELOC) wat 8.65 percent.

Thirty-year fixed mortgage rates dropped too, but because they are more closely tied to 10- and 30-year Treasury note yields, rather than the prime. On October 1, the yield on 30-year bonds dropped below 5 percent for the first time in 30 years, to 4.88 percent.

Before the Fed's move, the 10-year Treasury note yield, now at about 4.4 percent, was already at its lowest level since the 1960s, in part because of anticipation the Fed would cut rates. Investors' flight to the bond market after recent Wall Street jitters and the global economic plight also helped push mortgage rates to historic lows.

Freddie Mac's Primary Mortgage Market Survey this week put the average interest rate on a 30-year fixed-rate mortgage at 6.60 percent, the lowest in the 27-year history of the survey.

Economists say there's more room for rates to fall. "Mortgage rates are expected to fall maybe 10 or 15 basis points by end of year, that's down to about 6.5 by the end of year. We don't think it will go much lower than that," said Bob Barr, senior economist with Freddie Mac.

Competitive forces

That's partially because of the fierce competition underway for mortgages, both new and refinanced.

Chris Larsen, chief executive of E-Loan, Inc. a Palo Alto, Calif.-based Internet mortgage company said Sept. 29 was his company's busiest day in the two years its been operating.

Refinance activity reached 62.8 percent of all mortgage applications last week, up from 59.1 percent a week earlier, according to the Washington, D. C.-based Mortgage Bankers Association of America.

Refinance activity normally accounts for only about 20 to 25 percent of the market when rates remain steady for a year or so, says Brian Carey, an economist with the association.

All mortgage applications were up a whopping 124.4 percent over a year ago, the mortgage bankers association reported Sept. 30.

"I think rates could go as low as 6.25 percent," said Carey.

Over pricing

Some say the rates could fall even further, to 6 percent or lower.

"The rates are artificially high still. Lenders are holding back because they are real busy. Why lower the price when you have a line out the door?," said Earl Peattie, president of the Mortgage News Co. in Morro Bay, Calif.

"Consumers are paying more than they should for mortgages, based on where interest rates have dropped, in general. If rates stay down and refinancing drops, lenders will be forced to compete and that will bring rates down. Sure, as low as 6 percent," Peattie said.

Next week: How to lock in the lowest rate!

Published: October 2, 1998

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