The Federal Reserve Doesn’t Set Mortgage Rates, But…

Typically, a rate cut from the Federal Reserve reduces financing costs for consumers, in turn freeing up cash flows to be used on things like spending that stimulate the economy. This includes saving money for your client to buy a new home with the help of Orion. Last week the Federal Open Market Committee left rates unchanged. Does it matter for your clients?

In this cycle, the expansion in household debt has not occurred in variable rate categories that would see the greatest benefit (ARMs or credit card debt), but instead almost exclusively in fixed-rate categories like student and auto loans where rates do not move in conjunction with the Fed Funds rate. Even without additional rate cuts, the consumer is already on pretty solid footing, as personal consumption expenditures (PCE) are historically high, and household debt as a share of disposable income and as a share of the economy remains well-below levels seen prior to the financial crisis. Orion’s brokers are indeed seeing this as we move through December.

What if the FOMC had cut rates? With homeowners financing their purchases differently and consumers not accumulating credit card debt at pre-recession levels there may be less of an immediate boost for consumer finances from rate cuts. To be clear, consumers with an adjustable-rate mortgage may have been in store for some relief as lower rates equate to lower interest payments, but with most homebuyers (95 percent now versus 70 percent pre-recession) choosing fixed-rate mortgages the economic benefits to the housing sector from rate cuts in the future will likely be muted compared to prior cycles.

Experienced brokers know that mortgage rates in general tend to track more closely with the yield on the 10-year Treasury than the Fed Funds rate, which limits the direct effect the Fed can have on mortgage financing costs.

While mortgage debt still accounts for a majority of total household debt, it is down both in total amount outstanding and as a share of total household debt this cycle. As recently as 2009, student loans were the smallest category of consumer debt, but is now the second largest (after mortgages) today, and the largest category of debt for those aged 18 to 29 years of age. Auto loan debt is the only other category that has grown as a share of total household debt over the past decade.

You can’t drive your house to work, and of those consumers who have a bankcard, auto loan and a mortgage, those households are far more likely to default first on a mortgage than on any of the other two trade types, rather than miss a car payment. Remember, with the unemployment rate near an all-time low and consumer spending growing at a strong pace, easier money may not be needed at the moment for the consumer. Orion’s brokers have seen how student and auto loans have driven all of the growth in household debt in this cycle. So with the Fed leaving rates alone, well, it was expected and should have very limited impact on mortgage lending.

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