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The past seven weeks are a perfect illustration of why not to use the Federal Reserve Board's actions, actual or rumored, as a cue for mortgage rates.
Since Nov. 1, the Fed has cut interest rates by 75 basis points. A basis point is one one-hundredth of a percent. Yet in that same period, 30-year fixed mortgage rates have rocketed from 6.42 percent to 7.18 percent, a 76-basis-point increase.
Say what? How can mortgage rates rise at a time when the Fed is actively cutting rates? The explanation is represented by the difference between a microscope and a telescope.
When the Fed cuts short-term interest rates, the concern is for the here and now. To gain a true read on the state of the economy, data such as consumer confidence, consumer spending and unemployment are evaluated under a microscope.
Long-term rates, and ultimately mortgage rates, are determined in the bond market. These rates fluctuate depending upon what investors see on the horizon through a telescope. With the substantial stimulus of cumulative interest rate cuts, additional government spending and modest tax relief for consumers, these investors are peering through a telescope and seeing an economy that is capable of greater output in the future.
They are also likely to see a landscape that is indicative of higher inflation. For these reasons, investors command a higher return for investing in long-term securities offering fixed payments -- instruments such as government bonds and mortgage-backed securities. Mortgage rates move based upon these longer-range expectations, often regardless of the current environment.
Rising rates may make refinancing a mortgage considerably less attractive than it was one month ago. Those possessing an attractive rate to begin with, say 7.5 percent, may decide to forego refinancing altogether.
But, as rates on mortgages have been climbing, products impacted by cuts in short-term interest rates have continued to decline. Many home equity loans and lines of credit, as well as credit cards and personal loans, fall into this category.
Perhaps you cannot profitably refinance your mortgage now that rates have increased, but it is still a great time to reduce interest costs by consolidating higher-rate debt at lower rates. This can entail using a home equity loan or line of credit, or just finding a low rate credit card.
However, lower rates are only truly beneficial if the borrower continues to pay down, rather than add to, the overall debt load. The low-rate environment is very conducive to reducing interest costs and accelerating debt repayment, provided that any savings are also earmarked for debt reduction. But it may necessitate looking beyond the first mortgage and viewing the entire debt load.
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