Loan clues revealed by stocks and bonds ANALYSIS
Analysis: Loan clues revealed by stocks and bonds

By Richard Mize

Published: January 23, 2008

If the cost of bank-to-bank borrowing falls in a forest of cheap mortgage rates, does it make a sound — or a difference?

Probably not.

That's what Tuesday's surprise move by the Federal Reserve did: It lowered the interest rate that banks charge other banks for borrowing their excess reserves — a level of finance far removed from home mortgage lending.

So, no direct connection, no direct impact on home loans.

Continued historically low mortgage rates do bode well for people with adjustable-rate mortgages about to reset at higher rates: The new rates may not be as ruinously high as people assumed they would be just a couple of months ago.

But traditional 30-year fixed-rate home loans were coming cheap even before murmurs about recession reached the crescendo that apparently led the Fed to act.

Home loans can be had for around 5½ percent, compared with 6½ percent a year ago, said J.W. Armstrong, developer of the Fairfax Estates addition in Edmond. That means they're getting more house for their money than they were getting a year ago, he said.

Armstrong said construction in his residential-golf development and other nearby neighborhoods in north Edmond has remained steady and strong, even as skittish home buyers have caused a slowdown and an increase in the supply of homes for sale in the metro area.

The Fed action could turn some would-be buyers into actual buyers, Armstrong said, if they see the rate cut as a sign that the country as a whole can sidestep recession.

So, if not the Fed, what should people watch to anticipate changes in mortgage rates?

Stocks and bonds.

It's complicated, but it's almost like clockwork.

If investor demand for stocks goes up, demand for bonds goes down, so bond yields go up, 10-year Treasury bill rates go up, and mortgage rates go up because they generally follow 10-year T-bills, since most home mortgages actually are paid in seven to 10 years, when the average homeowner sells one house and buys another one.

So, if the eventual effect of the Fed's action is increased confidence in the economy, and that's reflected by confidence in stocks, it will shift money away from bonds, which will push bond rates up and mortgage rates up.

"Consumer mortgage rates are based on the trading of mortgage-backed securities, which have absolutely nothing to do with the bank-to-bank interest rates set by the Federal Reserve,” said Scott Senner, senior loan officer for Innovative Financial Services in Oklahoma City.

"Mortgage-backed securities are bonds and compete with stocks for investor dollars.

"When the stock market is rallying, investors are selling bonds to finance the rally, and typically mortgage rates will go up. When the stock market is in decline, investors will often buy bonds — like mortgage-backed securities — as a safe investment. This will typically result in mortgage interest rates going down.”

Considering a home purchase?

"Keep your eyes on the stock market,” Senner said. "The daily ebb and flow of the market is what matters most to the movement of mortgage rates. Stock market on the rise? Interest rates will typically be on the rise as well, and vice versa.”

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