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As expected, the FOMC (Federal Open Market Committee) often referred to as the FED, cut rates today. This is the first rate cut since June 2003. The rate cut was by 50 basis points – the analyst consensus was a 25 basis point cut. In addition and perhaps more important, the FED cut the Federal Discount Rate by 50 basis points. The discount rate is the rate charged by the Federal Reserve Bank to its eligible member banks and financial institutions.

The effect of an interest rate cut is often misunderstood. It is commonly thought that mortgage rates will edge lower when the FED reduces rates – however it often times has the opposite effect.

So why does this happen? A rate cut is already “built” into the market by the time the FED actually announces a rate cut. Mortgage Bonds trade based on the specific wording from the meeting about inflation concerns. Concerns over inflation will always have a negative affect on mortgage bonds.

The good news in the rate cut is that Home Equity Lines of Credit (HELOCs) will feel an immediate affect by a rate cut by the FED. The interest rate that HELOCs are tied to is what is referred to as the Prime Interest Rate. The Prime Rate is calculated by adding 3.00% to the Fed Funds Rate. So after the rate cut, Prime is now at 7.75%. Not all home equity is in the form of a line of credit so check with you lending institution to determine if you will get the benefit for the rate cut.

The immediate effect on Mortgage Bonds is positive - more than likely because the rate cut was greater than expected. As more details about the FED meeting are release I will update this posting.

Please feel free to call me if you would like to discuss the FOMC decision and its affect on you at 727-799-3331