Wednesday, January 14, 2009

Mortgage forecast follow-up, and romance

Dear Freakwenter,

You recently noted that many predict that mortgage rates will bottom in June around 4.5%. If this happens, what is the explanation for the increased spread between the "Federal Funds Effective Rate' and the "30-Year Fixed-Rate Mortgage Rate," shown in the chart above? What is preventing mortgage rates from dropping more?

The federal funds rate is a short-term interest rate, the rate by which banks lend to each other overnight. By contrast, the 30-year fixed-rate mortgage rate is a long-term interest rate. The crucial difference between the two rates is that the first one is short-term and the second one is long-term.

What does the term-length of a loan have to do with its interest rate? When a bank makes 30-year fixed-rate loan at X%, they are betting that the interest rate in the next 30 years will generally not exceed X%; otherwise, they would keep their money in short-term investments until the rate rises to something much higher than X%. The fact that long term interest rates hover near 5% while the short-term rates approach 0% reflects the market's expectation that that long-term interest rates will return to a higher level in the future; the banks are holding back their money in short-term investments until this increase occurs.

In regular English, a woman who hesitates to marry a reasonably good man because she is holding out for her perfect someone might be perfectly content to fill in her waiting time by doing one-night stands with men that she could never marry.


Anonymous dr perfection said...

oh, thanks, now I understand. that really clears it up.

7:08 PM  
Blogger Persimmon Hill said...

Well I'm sure glad that that short-term 0% investment option isn't the policy of anybody I know's.

6:12 AM  

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