For many people, the most important purchase that they can make in their life is the purchase of a home. Reaching a point in life where one wants to lay down roots and make a long term investment in a more secure life without the hassles of renting is an important milestone. Although the financial crisis and the housing bubble in this country has made it more difficult for some people to attain a mortgage loan, mortgage rates remain very low and will be for the foreseeable future, thus owning a home is still an attainable goal. But why do mortgage rates remain so low?
The mortgage rate is what determines the interest that someone pays on a mortgage loan when they borrow money in order to purchase a home. It does not really matter whether the home loan is a short term five year loan or a more typical 30 year fixed rate home loan. Either way, interest must be paid on the loan. A mortgage payment then is a combination of the interest that is owed on the outstanding balance of the loan and the principal itself. The principal is simply another name for the amount of money borrowed minus the interest. Differences in interest rates can have a significant impact on the payment. For instance, a one percentage point difference in interest rates translates into a ten percent difference in the monthly mortgage payment.
Although the Federal Reserve does not directly determine interest rates, it does have a significant influence on what those rates are. It does this in two ways. First, the Federal Reserve is responsible for raising and lowering the discount rate. This is the interest rate that banks are charged when they borrow from the Federal Reserve. Secondly, the Federal Reserve indirectly influences the direction of the Federal funds rate through government policies. Since mortgage loans are actually securities that are traded in the secondary market, the interest rate is influenced by the actions of these investors and not the bank itself.
The biggest influence on mortgage rates is the state of the economy itself. In a slow growing economy, there is very little worry over inflation, and businesses and households have lower than average demand for loans. Since the Federal Reserve attempts to employ policies that influence the United States economy in the direction of growth and prosperity and high employment, it has enacted policies like quantitative easing and “operation twist” to put downward pressure on interest rates to encourage investment and borrowing. “Operation twist” is a complicated action whereby the Federal Reserve buys short term treasury securities to reduce the number of these securities in the market and increase the number of longer term securities.
As stated above, mortgage loans are actually securities that are traded on the secondary market. During the housing bubble and the recession, it was a combination of predatory loaning practices and very complicated financial shenanigans in trading these loans that created the crisis and affected the entire market. But surprisingly, American backed mortgage securities are still considered very safe loans for investors, because in economically uncertain time investors look for safe assets to invest their money, investors continue to buy these securities. The Federal Reserve wants to continue to support this economic activity, thus they set policies that ensure investors continue to invest in these loans.
Gerald Franks writes articles for several insurance sites including Kanetix, where you can compare insurance rates.