Interest rate predictions are a sign that the banking system is struggling. The Fed keeps lowering Federal interest rates, but mortgage interest rate predictions are still going up – how can this happen?And what might it mean for home owners today?

The idea that home owners need to understand when it comes to interest rate predictions is how the interest rates set by the Fed and mortgage interest rates charged by mortgage lenders are connected.

Interest rates that are set by the Fed flow into the cost of funds to mortgage lenders. Banks and other lenders don’t start out with all the money they lend out – they usually borrow on the wholesale market 90% of what they lend out to home owners, at rates lower than the mortgage rates they charge.

When the Federal Reserve lowers interest rates, it lowers the borrowing costs for mortgage lenders. You would think, in that case, that interest rate predictions would fall. However, mortgage lenders may choose not to pass on the reductions to mortgage holders.

The reason is not greed – there is enough competition in the mortgage market to ensure that no lender can profit unfairly. The motivation is that being a mortgage lender in today’s market is a whole lot more risky that it used to be, and perceived risk raises interest rates.

Mortgage lenders are charging everyone more interest to offset their losses on the few who will fail to pay their mortgages.Until the plummeting housing market levels out, the risk of default will be high, and interest rate predictions will keep rising.

Of course, the government can’t lower interest rates continuously. The quoted interest rate (called the “nominal” rate) includes an inflation factor. To find the “real” interest rate, you subtract inflation from the nominal interest rate.

The thing is, when you do that just now, the result is a negative number! It’s a real anomaly – nominal interest rates are lower than the inflation rate.

Without a doubt, this is a situation that really cannot continue for too long. Sooner or later, probably sooner, the Fed will have to raise interest rates to at least break-even levels, matching the rate of inflation. This interest rate rise will definitely flow through in to mortgage interest rates.

In other words, it’s only a matter of a short time before mortgage rates rise again.

Express Yourself