Fed Slashes Their Rate

The Fed has cut their rate twice in the last 2 weeks dropping the Prime Rate to 6%. That's very good news for long suffering Home Equity Line of Credit borrowers. They've paid as their rate went from 4% (yeah that's right) to 8.25%, now back down to 6%. Some jumbo mortgage borrowers now have a Home Equity Line of Credit at a rate lower than their 30 year fixed 1st mortgage.

The Fed Rate is not directly tied to 1st mortgage rates, as many think. The Fed Rate is the the interest rate at which banks borrow money for day to day business needs, or to shore up their overnight reserves. 1st mortgage rates are more closely tied to the 10 year Treasury bond yield. That's what consumers should be watching to find out if it's time to refinance.

The Fed Rate is directly related to the Prime Rate though, so Home Equity Line of Credit borrowers should keep track of that rate closely. There should be some payment reductions coming the next billing cycle. One suggestion as the Home Equity Line of Credit rates drop: Keep making the same payment as when the rate was much higher, that way you will pay down some of the principal. Generally, the payment due on your statement is an interest only payment. If that amount is paid the principal balance remains the same, the debt is being serviced, but not paid down. A discretionary principal payment must be made each month in order to payoff this type of mortgage loan. And the way this loan's rates fluctuate up and down, it's a good idea to pay it down as much as possible.

Fed Rate Cut, Why Not My Rate?

The recent Fed rate cut to 4.75% is more directly related to the interest of Home Equity Lines of Credit as they are generally tied to Prime (currently 7.75%). Since Prime floats 3% above the Fed Rate there is a direct relationship between the two.

Counter-intuitive though is why the 30 conforming (Fannie and Freddie) fixed mortgage interest rate has gone up a bit since the most recent Fed rate cut. The bellwether for the conforming fixed rate is the 10 year treasury bond yield. That has been increasing as investors have been selling off bonds the last few days. The reason for the sell-off is that investors worry that the Fed rate cut might kick-start inflationary pressures.

So, despite people's wish for the opposite, the Fed rate cut has negatively impacted mortgage rates for the short term.

30 Year Fixed Rate Interest Only

The subprime market is imploding or exploding, depending on which side of the fence you are standing. The rumors circulating among homebuyers are that all interest only mortgages are risky and should be avoided. In many cases that may be true, but I think, more true, is a confusion among buyers about mortgage programs in general.An interest only mortgage is not a subprime mortgage necessarily. In fact, it's generally an option for only the most qualified buyers. It even makes sense for those who plan on prepaying the balance of their mortgage on their own. Why? Payment recast.With a 30 year interest only mortgage, the payment due each month is an interest only payment. So on a $400,000 mortgage at 6%, the monthly interest only payment is $2000, rather than the principal and interest payment of $2398.20, where $2000 is the interest payment and $398.20 is paying back the loan each month at the same 6% interest rate.If a well-qualified, disciplined borrower chooses the interest only option, and continues to pay the same payment as the fully amortizing payment, her payment will be reduced based on the new principal balance each month.Here's an example:Keiko, buys a $500,000 coop here in New York City. The coop requires a 20% down payment, so her mortgage is $400,000. She decides on a 30 year fixed rate interest only mortgage. Her first month's payment is $2000, but she pays $2398, indicating that the additional amount goes directly toward principal on her statement when she mails her payment. The next month, her payment is reduced to $1998.01 based on the new loan balance of $399,601.80. If she continues to pay $398 in addition to the interest only payment each month, at the end of the first year, her interest only payment will be reduced to $1976.11. If she chooses, she may elect to pay the interest only payment giving her the freedom to spend the difference in another manner (hopefully paying down credit card debt that's more expensive).Her payment is reduced to reflect the lower principal balance offering her immediate gratification for her discipline. A well disciplined borrower may welcome the freedom of being to either pay down the principal or put the money to use elsewhere on a month to month basis while having the security of a fixed rate for the life of the loan.