During his 19 years as a real estate agent, Fudgy Brabham, owner and broker-in-charge of Harbourtowne Real Estate in Mount Pleasant, has seen market trends come and go.
But one constant during that time has been a common misconception among some homebuyers that when "the Fed" tinkers with the interest rate, as it has done three times this year, mortgage rates will follow suit.
Frequently, buyers are tempted to wait and see if they will benefit from a rumored drop in rates, Brabham said. And during periods of gradual decreases, he said, home sales lag as buyers often choose to sit on the fence and wait to see what will happen next.
"There really is a misunderstood correlation between Fed rate drops and mortgage rates," Brabham said. "Buyers think mortgage rates will follow suit."
But that's not the case.
In fact, when the Federal Reserve lowers its federal funds rate, mortgage rates sometimes actually rise, as happened earlier this month.
The Federal Reserve sets targets for short-term interest rates, such as the federal funds rate, the rate one bank pays another for borrowing money overnight to maintain minimum reserve requirements for loans. This short-term rate affects what rate consumers pay on credit cards, home equity loans and other short-term financing.
Long-term interest rates, including mortgage rates, are determined by the market. In other words, they are "set" by the bond market, in a similar way to how the stock market sets stock prices.
Banks, brokerage firms, pension funds and a long list of other investors bid for bonds when the Treasury sells them every three months. The greater the demand — the higher the bids — the less the Treasury has to pay in interest to sell them.
Any adjustment by the Federal Reserve generally is geared toward steering the U.S. economy, said Chip Hardy, a registered investment adviser with PrimeTrust Advisors in Columbia. But the economy is like a giant cargo vessel: It does not respond immediately to a slight adjustment in course.
"The big picture, the macro picture, usually takes six to eight months to flush through," Hardy said. "In the Fed's eyes, six to eight months isn't a long time."
The Federal Reserve's job, in part, is to look at the gross domestic product and a host of other data and try to head off trends they see happening in the months ahead, Hardy said. Any adjustment today is designed to have a trickle-down effect. Very often, the goal is to get consumers comfortable about spending money again, he said.
But it's difficult to find any clear connection between the Fed's actions and mortgage rates.
Since the beginning of 2000, the difference between the average 30-year conventional mortgage rate and the federal funds target rate has varied widely from as little as 0.63 percent to as much as 5.44 percent.
This year, the lowest that the 30-year mortgage rate has fallen was 5.96 percent the week of Dec. 6. The Federal Reserve lowered its federal funds rate target the following week to 4.25 percent from 4.5 percent, but the average 30-year mortgage rate rose that week to 6.11 percent.
Mark Vitner, senior economist for Wachovia Corp. in Charlotte, said the Federal Reserve is reducing the federal funds rate because financial institutions are having trouble funding themselves. Many banks are stuck with assets they intended to sell on the securities markets, but then found aren't as attractive in the current economic climate as they once were, forcing them to carry those assets on their books and look for other sources of cash.
And even though market-based rates on Treasury bonds have dropped much more than the Fed's rates, Vitner said he doubts mortgage rates will get much lower.
Though it sounds illogical, experience has taught Brabham that an increase in mortgage rates can provide the boost the real estate market needs.
During previous periods of flat rates, Brabham said, he found that many buyers were ready to make a move, had financing in place, but were waiting to see if rates had bottomed out before acting.
As soon as rates rose, "It was as busy as it could be," he said.