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Will Fed Rate Cut Save the Housing Market?

The Federal Reserve announced a surprise rate cut this morning before the U.S. markets opened.  The move lowered the Fed Fund Rate to 1.5%.  This is their second surprise rate cut this year in the face of deteriorating financial markets.  The latest rate cut of 0.5% was coordinated with five other central banks, working together in response to a steep overnight drop in many overseas markets.

In response, futures initially spiked along with the bond prices.  By 9:30am EST though, both futures & bond prices had cooled as the euphoria wore off.  The National Association of Realtors announces their August pending home sales figures at 10am EST today.  Expectations are that the figures will be down 1.2%. 

What’s this mean for the Housing Market?

Traditionally, the main focus of homebuyers has been payment affordability.  That’s how the housing market & the economy got into this mess in the first place – low rates and easy money led to the creation of exotic mortgage products that artificially lowered monthly mortgage payments.  The lower mortgage payments led to homebuyers bidding up the prices of houses, creating a housing bubble that proved to be unsustainable.  We’re approaching the 1% Fed Fund Rate that initially spurred this sequence of events.

This time around though, the housing market still has a hang-over from the last “party” and homebuyers are staying home.  Despite low mortgage rates & falling house prices, not many appear to be buying. 

Mortgage rates, while still historically low, are about 0.75% above their lowest point reached in June of 2003.  On a $200k mortgage, this difference in interest rates leads to about a $96/month difference in a mortgage payment.

Falling housing prices though, actually more than make up for rates not being at their lowest.  Dropping the mortgage amount in the above example to $184,200, leads to the same payment difference of $96/month at today’s interest rates.  That’s only an 8% drop in the mortgage amount.  Most housing markets around the country have experienced at least an 8% drop in prices, which would lead to the same drop in the amount a home buyer has to finance.

So, why aren’t people buying homes?  A lot of it has to do with fear – fear of the economy, fear of job loss, fear that home values will keep falling.  A lot of this fear is irrational.  The stock market is down to levels not seen since October 2004, but home prices were still rising back then.   Unemployment is only at 6.1% for September, about the same as it was for most of 2003 when home prices were rising.  So, that leaves us with the fear that home prices will keep falling.

Who wants to buy something that you know you can get for less next month?  Why not wait?  That seems to be the main reason so many are waiting to buy.  The fears of the economy and job loss just validate the fear of falling home prices.  The Fed’s rate cut might stabilize Wall Street and world markets, but won’t directly address the fear of falling home prices.

So, it’s unclear how effective the Fed rate cut will be in addressing the issues facing the housing market.  The federal government’s plan to purchase toxic mortgage-backed securities won’t directly affect the housing market either.  According to McCain & Obama, that means the economy may still be in trouble. 

The lone hope for a housing recovery rests with the rumored federal effort  to increase mortgage modifications to keep more people in their homes.  If implemented (correctly) it will mean less foreclosures on the market, bringing down the supply of homes, which will stabilize prices.

Drew Sygit is President of The Lending Edge and holds mortgage industry designations CMPS, CMLO, CALO and has an MBA.  He’s spoken for HUD, has written numerous articles and is a mortgage industry advocate for loan originator licensing and consumer education.  He can be reached at 248-356-3739 or dsygit@TheLendingEdge.com.