Low Interest Rates - a Gift for Buyers?

Mortgage interest rates are the lowest they have been since the 1950s. One only needs to open up a newspaper to see the barrage of articles discussing interest rates. The reasons behind the dip are many, but the predominant reason is the action the Federal Reserve (The Fed) has taken to drop key interest rates across the board.

The Fed acts as a quiet guardian, monitoring even the most minor fluctuations in the economy. By adjusting the Federal funds rate, or the interest rate which banks charge each other, the Fed can adjust rates affecting everyone in the nation. The Fed increases interest rates to make borrowing less alluring and thus deter an economy that is growing too fast. You might ask why would the Fed want to slow down the economy, isn’t a rapidly growing economy the prerogative of the Fed? True, this is one of the Feds roles, but unfortunately the economy can grow too fast and rapid growth can sometimes lead to uncontrolled inflation.

When the economy slows down however, and the Fed notices some weaknesses in the mesh, it lowers interest rate. A low interest rate makes borrowing money seem much more attractive and thus there is more cash flow. The renewed cash flow further invigorates the economy and it eventually it begins to grow.

After the recent economic recession, a recession that some believe is still not over, the Fed has dropped interest rates. Even though mortgage rates are not directly connected with the funds rate, banks offering mortgages tend to model mortgage rates after the funds rate. Simply, whenever the Fed makes a decision to lower the interest rate, the mortgage interest rate also decreases. Thus, it makes perfect sense for mortgage interest rates to be at an almost all-time low.

The average rate for a 30-year fixed mortgage is now a 4.58%, almost a full percentage point less than the rate a week ago. 15-year fixed mortgages are down to 4.13%
However, with lower mortgage interest rates comes the question: What does this mean for you as a buyer?

Well, obviously it makes buying a home much more affordable. With lower interest rates you can now afford to buy “more” house. However, a lower interest rate does not mean you should go out and buy the biggest house you can afford. A savvy buyer will use a decreased interest rate in order to buy a house that will not prove overly difficult to pay off. Resist the temptation to buy a house you can barely afford!

Interestingly enough, however, even with the tremendous drop in mortgage interest rates, buyers are sparse. Mortgage applications are constantly falling, and the purchase index of the Mortgage Bankers Association is at 13-year lows. This may not make much sense. Why are people not buying homes at a time with the lowest interest rates in the past 50 years? Well, with the advent of the housing crisis, credit standards have risen. Fannie Mae and Freddie Mac are not buying as many mortgages as they used to; as a result banks are less likely to loan people money for mortgages. By raising their standards, Fannie Mae and Freddie Mac have caused banks to raise theirs. Banks no longer want to keep mortgages on their books, preferring to sell them. The largest buyers of mortgages were and still are Fannie Mae and Freddie Mac. Now that the two companies are hesitant to buy mortgages from anyone but the most pristine buyers, most banks only lend to people they know will fit this criteria.