Posted at 11:05 a.m., Wednesday, October 3, 2001

Fed cuts unlikely to lower mortgage rates further

USA Today

Borrowing costs for banks dropped to the lowest level in 39 years after the Federal Reserve's rate cut yesterday.

Home buyers won't be so lucky.

"Rates are not going to be as low as the '60s," said Bert Ely, an Alexandria, Va., banking consultant.

The federal funds target rate fell to 2.5 percent, a level last seen in 1962, when John F. Kennedy was president. At that time, a long-term home mortgage carried a rate of about 5.8 percent, nearly a percentage point below today's 6.7 percent average for 30-year financing. The prime rate, a benchmark for pricing a variety of bank loans, was 4.5 percent in 1962, vs. 5.5 percent today.

So why aren't consumer costs plummeting to Kennedy-era levels along with the cost of money to banks?

Experts say home lending is a different business today. Now lenders typically bundle mortgages and sell the debt to bond investors in what's called the secondary mortgage market. So it is bond investors who effectively set the rate at which bankers will lend.

In 1962 the secondary market was a pup. Typically homes were financed by a thrift institution lending the money it brought in from depositors. Think George Bailey's building and loan in the film "It's a Wonderful Life."

Bond investors demand greater return than George Bailey, partly to guard against inflation. They're also hedging against the boom in consumer refinancing. When a homeowner pays off a mortgage early, the bond investor must reinvest the payoff money, presumably at a lower interest rate.

Another factor: The George Baileys of old didn't have an attractive alternative to making sub-6 percent home loans. The average yield on 10-year Treasury notes, an alternative investment to long-term home loans, paid a yield of just 4 percent in 1962, even lower than today's meager yield of about 4.5 percent.

So far, nine months of Fed rate cuts haven't had much effect on long-term mortgage rates.

Since the Fed began easing credit in January, the yield on the 10-year Treasury has dropped about 0.75 points, twice as much as the drop in the average 30-year mortgage rate. Robert Van Order, chief economist of giant mortgage investor Freddie Mac, said mortgage rates never have moved in lock step with short-term rates.

Long-term mortgage rates are still a good deal. The September average for the 30-year fixed-rate mortgage will be less than 7 percent for only the 15th time in the 30 years Freddie Mac has tracked them.

Ron Szuch, at Union Capital Mortgage, Cleveland, is offering 30-year mortgages at 6.5 percent and no origination points.

"I don't look for it to get much better," he said, adding that he believes the Fed has exhausted its influence on home financing costs.