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So many times in the news you hear that the Federal Reserve has cut interest rates. Shortly thereafter clients begin calling and ask me how much the interest rates on mortgages have dropped.
First point, the Fed rate is the rate at which member banks may borrow short term funds directly from a Federal Reserve Bank. The discount rate is one of the two interest rates set by the Fed, the other being the Federal funds rate.
So what does this mean? Very simply when the Fed Rate drops the interest rate at which banks borrow money drops as well. Therefore when the Fed’s cut rates the banks can borrow money cheaper.
Now the real measure of how interest rate will change with respect to mortgage rates is the yield on the 10-yr Treasury Bonds. When these bonds go up the yield goes down (it is an inverse relationship for those of you who understand some basic mathematical principles). When the yield drops the rates on mortgages generally drop. One thing I would like to point out from my observation of the markets, sometimes the Fed cuts rates and the stock market begins to rally. This rally brings the prices of stocks up and people begin to sell bonds. When the price of bonds begins to drop their yields go up and as a result the interest rate on mortgages goes up as well. I have also seen times when the Fed has cut rates and the interest rates on mortgages have dropped.
So how do I know if interest rates will drop? The general rule is to track the yield on the 10 yr treasury bonds and if I really knew how to track bonds each day maybe I would be a bond trader on Wall Street.