Home Loan Lending

By: EconomyWatch Content   Date: 23 December 2009

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Interest rate is one of the most crucial factors to consider when it comes to home loan lending. Mostly, individuals begin to follow the footprints of the Federal Reserve (fed) rates to identify and analyze home loan interest rate trends. However, to understand this economic equation, one should know how the fed rates affect home loan interest rates.

Home Loan Lending: The Effect of Fed Rates

 

Fed rates do not affect home loan lending rates directly although they do exercise great control over what homeowners have to pay for a mortgage. The Federal Reserve takes various crucial decisions to determine the growth of the economy. The decisions on Fed Funds Rates and discount rates affect the home lending rates. Actually, Fed Funds Rate is the interest rate that is charged by banking institutions over one another for overnight loans. These loans determine the exchange of excess reserve funds among depository institutions. However, discount rate is the interest rate that Fed charges from the commercial bank for lending money.

 

When financial experts say that Fed has raised or lowered home loan interest rates, their indication pertains to a change in Fed Rate or discount rate. To tame the economic anomalies, the Federal Reserve changes the financial targets for the banks, which means that the Fed Rate and discount rate tend to change. Thus, banks have to either raise or lower the home loan lending rates to achieve the target.

 

For a short-term loan, a Fed Rate cut has direct impact on the interest rates. It also brings the opportunity to refinance home loan. Long-term loans have no direct relation with a Fed Rate cut. The interest rates on long-term loans, like a 30-year loan, are determined by the investors in the bond market. However, a change in Fed Rates indicates future economic situation. So, lending institutions prefer to change interest rates on long-term loans.

 

The Fed Reserve also affects home loan interest rates in several other ways. For example, the Fed can buy treasuries, debt instruments and short-term securities backed by the mortgages to bring down home loan interest rates. Low interest rates encourage people to purchase home loans. Thus, Fed decisions boost economic cycle in the nation.


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