I get that the fed funds rate influences mortgages: it goes up so do mortgage rates. But can anyone explain why there is such a high difference between fed funds (I believe it’s 1% now) vs mortgages (5-6%)? I know also that banks apply all sorts of premiums (default, market risk…) but why are they that high?
As a comparison, mortgage rates in the EU are still sub-2% with ECB rates at zero.
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Because the banks want to make money. It’s a free market – a bank will factor in the risk of lending and desired profit margin, as long as it remains competitive , it will charge to maximize the profit. Rates in Canada are in the 1.8-3% too
Because they’re made to screw us over. Even the word tells you. Mort – means Death, and gage means pledge. It’s a death pledge. Debt until you die (30 year loan lol)
In a super nutshell that’s more for broad concept not specific accuracy, in our current system banks don’t just keep billions of dollars in cash on hand hoping to make loans. What they’ll do is make a dozen loans during the day and then take a loan out from the Fed that night to cover the loans they made. So you pay your mortgage, the banks pay back the Fed.
So as a baseline, you can expect the bank rates to always at least have the Fed rate “baked in”. If it goes up, the mortgage rates up accordingly.
But on top of that the bank is a business, it’s looking to make money. It’s the banks math to work out, but they might say “we want at least 3% of any mortgage we offer as profit”, so now that bank’s mortgage rates are going to be 3+Fed rate.
On top of *that* the bank now needs to factor in things like risk of default, risk of losing clients due to undesirable rates, risk of other random things they are looking to hedge with their mortgage business. Etc.
So now you get math like 3% + Fed Rate +/- adjustments to seal the deal.
It’s not really fair to apples to apples compare different nation’s mortgage rates, there tons of other factors like local and regional laws, trends in “how they bank” and the current economic situation unique to each location.
The big difference is mortgage rates are for 15 or 20 or 30 years, while the fed funds rates are much shorter term. If you’re lending money out for 30 years, and you can borrow at 1%, but you worry that tomorrow you might have to borrow at 4% or 5%, then you’re not very likely to lend money out at 2 or 3%.
1) There is a risk you may default
2) The interest rate is not necessarily what bonds yield
So far some very wrong answers, and some sort of half right answers.
First off, the fed funds rate and mortgage rates are not comparable. It is more accurate to compare the 10-30 year bond rates to mortgage rates. In that case you have a 3% vs 5% difference. Fed funds rate is a rate at which banks loan to each other, and is more closely anchored to the rates of the repo/reverse repo market, which is what banks and the fed pay to lend to each other. There is a lot of complexity in all of that so I wont go into it.
**The reason mortgage rates have gone vertical lately**, and greatly outpaced the rise in fed funds rates is simple. The fed spent the last 2 years buying a shitload of mortgage backed securities. They are now approaching a time where they are going to start unloading a lot of those as a way to put the breaks on the crazy housing market. They will be unloading way more than the market will be able to reasonably absorb under normal conditions. So basically the supply of Mortgage Back securities is going to be more than the demand, as such their prices will have to come down(which makes the rates go up), to find buyers. The market is preemptively pricing this in.
Because the banks want to make money.
Because the middle-men inbetween want to make money
Because a certain number of people will default on the loan and walk away.
Whenever there is mortgage rate talk, I like to point out that my savings account makes 0.03 % interest.
So money is not all the same. Banks don’t mind you lending them money (which is what your savings are) at a low rate, to fund their mortgages to other people.
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