AP

As we all eagerly await the Fed decision at 2 pm today, I want to just clarify what exactly a rate cut will and will not affect.

It’s pretty well accepted now that the Fed will lower its key short-term interest rate (“the Fed Funds rate”) by probably a quarter point, maybe a half, but that’s the outside bet. So what exactly does that do to residential mortgage rates?

The 30-year fixed: not much. The 30-year fixed is not tied to short-term treasuries. Fixed mortgage rates are tied to long-term bond yields that move based on the outlook for the economy and inflation. True, even as the Fed has lowered rates since the summer, the 30-year fixed has come down, but that’s because of the outlook for slower economic growth in the months ahead. While the decline in treasury yields has helped push mortgage rates lower, the decline in long term rates hasn't been in lockstep thanks to the fact that these mortgages are securitized and sold on the global market. Investors now demand a higher risk premium on these mortgages due to higher delinquencies and foreclosures.

5-1 ARMs: Yes, this is good news if your 5-year ARM is pegged to a treasury index. The one-year treasury is a common index for many adjustable rate loans, and it has plummeted from 5 percent in July down to now about 3.25 percent. So if you’re facing a reset on, say, a $200,000 loan, you’re now getting a payment increase of about $150 a month, as opposed to $370 a month, which you would have had before the Fed started cutting rates.

Subprimers: Nope. Unfortunately if you have a subprime ARM it is more than likely pegged to LIBOR, which has moved in the opposite direction. Because of the liquidity issues in global financial markets, LIBOR rates have actually increased at the same time that treasury and other benchmark yields have been declining, so the Fed lowering rates today would not help too many subprimers.

HELOC: Yes, if you have that home equity line of credit that you used to renovate your bathroom/kitchen recently, then when the Fed lowers rates, your rate comes down as well. That’s because HELOCs are predominantly pegged to the prime rate, which moves in step with the Federal Reserve. The cumulative effect of the Fed’s interest rate cuts over this fall have taken the average home equity line of credit from 8.25 percent now down to about 7.5 percent. With an additional rate cut, that will fall lower.

Questions?  Comments?