Fed rate cut--How it will affect mortgage market

Here is an exert from a good article by Kathleen Pender at the Associate press: 9/18/07:

People with home equity lines of credit will benefit first. These variable-rate loans are typically tied to the prime rate, which closely follows the federal funds rate. The prime rate is 8.25 percent today. If the federal funds rate drops by a quarter point, the rate on home equity loans will likely follow suit in the next month or so, says Keith Gumbinger, a vice president with HSH Associates.

Borrowers who have an adjustable-rate mortgage tied to the one-year Treasury yield could also benefit from a rate cut, though not directly. Treasury yields fell this summer, partly in anticipation of a Fed rate cut. An actual rate cut will help keep those rates low and if the Fed indicates a willingness to cut rates more aggressively, they could fall further.

"In early July, a Treasury-based ARM was around 7.75 percent. Now it's around 6.75 percent," says Gumbinger.

If you took out a Treasury-based ARM that was fixed for three or five years and the rate is about to go up, you will still see a big payment jump. It just won't be as big as it could have been.

On the other hand, people with ARMs tied to the London Interbank Offered Rate might not get any relief from a Fed rate cut. While Treasury rates were going down, Libor was going up. Although they normally move in the same direction, corporate credit concerns have put upward pressure on Libor and downward pressure on Treasury yields. A Fed rate cut won't automatically lead to a lower Libor rate.

Likewise, fixed-rate loans won't necessarily get cheaper. Unlike ARMs, which are tied to short-term rates, fixed-rate loans follow long-term interest rates, such as the 10-year Treasury note yield.

Over the past two months, rates on conforming fixed-rate mortgages - which can be sold to Fannie Mae and Freddie Mac - have fallen along with the 10-year Treasury yield. But they won't necessarily fall more if the Fed cuts short-term rates, and they could conceivably go up if investors fear that one or more rate cuts could stoke inflation"