How the Federal Reserve Affects Mortgage Rates
The Federal Reserve System, known colloquially as the Fed, actually doesn't control mortgage rates as you might think, but it does influence them. The much-ballyhooed announcement you hear on the news each month concerns the federal funds rate, which is a short-term interest rate that affects how banks loan money to each other. The prime rate, which is of much more relevance to ordinary consumers, is generally 2 to 3 points higher.
The prime has its most direct impact on credit lines such as credit cards and certain home-equity lines of credit. As the federal funds rate goes up or down, so does the prime rate at most lenders, which in turn sets the rates paid by various borrowers, including you.
But what about mortgage rates? For the most part, the rate you pay on your mortgage hasn't much to do with the Fed. More influential is the mortgage-backed securities market, which — as discussed throughout this book — does a more efficient job of setting the rates you pay.
The bottom line is that the Fed is looking at the big picture. Lowering interest rates encourages consumers to spend and thus, hopefully, ignites a slowing economy. When the Fed raises rates, it's generally trying to get everyone to quit spending so inflation can't take over.
In Appendix F, you'll find a worksheet that will help you figure your net worth — that is, the difference between your assets and liabilities. Even if you've never thought about your net worth, you can be confident that your lender will.
Doing a net-worth assessment is a valuable exercise because it will start to give you an idea of, in the vernacular, “how much home you can afford.” Actually looking at what you owe versus what you make each month will show you what you can afford to pay in mortgage each month before it becomes a squeeze.
You should absolutely consult a tax advisor before you borrow. Your tax situation is unique to you, and it might provide particular incentives and disincentives to buy property as well as sell. Always consult a tax professional when a major lifestyle issue includes money.
If the thought of taking pen to paper seems like a waste of time, consider putting financial tracking software on your computer. Quicken is the market leader, but there are other programs that will do the trick. This will not only help you get a net-worth snapshot, it will train you to record your daily spending and budget your spending as a whole. If you have never closely measured your spending before, you will really need to do it after you buy property.
