Fed funds rate cut and its effect on mortgage rates

Big news last month when the Federal Reserve (The Fed) cut interest rates. But what rates did they cut? They did NOT cut mortgage rates. In fact, the Fed cannot cut mortgage rates, at least not directly. The Fed recently cut the “discount” rate only, but has not (as of the date I write this article) cut the federal funds interest rate.

But what’s the difference between the two? The discount rate is the rate at which banks can borrow money directly from the Fed. Banks borrow from the Fed when they have an urgent need for liquidity (cash in hand). The federal funds rate is what they pay when they borrow from another bank. This type of loan is most often used when banks want to lend more money to consumers. Both of these types of loans are very short-term loans, often just overnight.

The Fed does not set interest rates on mortgages, car loans, credit cards, etc. But by setting a target rate for the federal funds rate, most banks try to fall in line around that number. Remember that the federal funds rate is the one that is related to getting more money into the hands of consumers, so that impacts you directly.

So by lowering the discount rate, which really only affects a bank’s liquidity, but not consumers directly, the Fed is saying that they recognize there is a problem, but they are taking a measured approach to trying to solve it. The general consensus among Fed watchers is that a reduction in the federal funds rate might come in September. This should result in a lowering of mortgage rates, which will help our real estate market.

By the way, if you’d like to see something hilarious (and at the same time scary), go to www.YouTube.com and search for “Cramer on rate cut.” This financial “expert” has a meltdown on TV screaming for the Fed to lower the federal fund rate.