Fed rate cut should have little impact on mortgage rates

Well the FED today lowered both the Federal Funds Rate and the Federal Discount Rate from 5.25% to 4.75%, but this should have little impact on mortgage rates. The reason for this is that mortgage companies have a liquidity problem. They don't have money to loan so therefore they are charging a premium for the money they have. Why don't they have the money? Without insulting anyone's intelligence let's take a quick look at how a mortgage works and how the companies make money

First, company A writes you a home loan for $100,000 over 30 years. At the end of the 30 years it is worth $285,000 from the interest being paid. The mortgage company write mortgages, not holds mortgages. So they sell their $100,000 mortgage on the secondary market for $150,000. This gives them their $100,000 back to write more loans, $50,000 for profit and the other company assumes the RISK and has the potential of earning $135,000 profit. Here's  where the liquidity problem lies. The secondary market is stuck with the risk, so they are not buying the loans the mortgage company is writing. So now the mortgage company doesn't get their $100,000 back. Now they can't last with out cash, because without cash they have nothing to loan. So they increase the interest rate making the potential pay off more attractive to the secondary market. This also allows for more money sooner, thus helping to off set some of the loss if the buyer defaults.

Here is the definition of the secondary market from ABOUT.com;

The secondary mortgage market allows banks to sell mortgages, giving them new funds to offer more mortgages to new borrowers. If banks had to keep these mortgages the full 15 or 30 years, they would soon use up all their funds, and potential home buyers would have a more difficult time to find mortgage lenders.

So there you have it. Hope this made`sense and wasn't too boring. If you have any questions or need any help call me at 760-415-3329.

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