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What Does the Fed Rate Cut Mean for Real Estate Investors?

[Updated: Dec 28, 2020 ] Mar 21, 2020 by Liz Brumer
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On Sunday, March 15, 2020, the Federal Reserve (the Fed) announced an emergency rate cut, lowering the Federal interest rate to between 0% and .25%. This sudden reduction in the Federal interest rate is an attempt to counteract the slowing of the economy, which recently came to a halt in an effort to stop the continued spread of the coronavirus.

This abrupt change in rates leaves consumers and real estate investors wondering how it will affect them.

The role of the Federal Reserve and Fed interest rate

Before you can understand how this rate cut will impact real estate investors in particular, you have to first understand what the Federal Reserve does.

The job of the Federal Open Market Committee (FOMC) is to establish policies that help govern and regulate the economy, including inflation rates, the supply of money, and economic growth and expansion, and define the cost of credit through the Federal rate.

The Federal base rate defines the cost for short-term borrowing in the financial market, particularly for banks and financial institutions borrowing and lending money to each other. Ideally, a low Federal fund rate should promote financial institutions to continue operating as usual, borrowing and lending money freely. It also should have a positive effect on the bond market, specifically 10-year Treasury bonds, which recently reached never before seen lows.

While the Federal interest rate does not define mortgage rates, it does impact them. Whether you're a real estate investor with a current mortgage or looking to get one, here's how the rate cut will affect you.

How the rate cut will affect new mortgages

Interest rates are still near historic lows overall, but over the past week mortgage rates have actually increased despite the Fed lowering the Federal interest rate to nearly 0%. That's because the mortgage market doesn't mimic or match the Federal base rate but closely relates to Treasury yields, which saw a recent surge after the Fed announced their plan for quantitative easing.

Those seeking a new mortgage can lock in a relatively low rate now or wait it out to see whether rates will lower in the coming weeks as mortgage applications slow and the true effects of the coronavirus are better understood.

How the rate cut will affect refinancing

Since the Federal rate cut was announced, applications to refinance rose 4% in just one week's time. The surge in new refinance applications has been another factor motivating banks to increase mortgage rates slightly for the time being.

Refinancing at the current rates may make sense for real estate investors with higher interest rate loans; however, the cost and fees associated with a formal refinance may not justify it. Lenders and banks seem very receptive and understanding of the current crisis and are open to working with borrowers to reduce the likelihood of defaults in the future.

Right now may be a good time to reach out to your lender to see if there is an alternative option outside of a formal refinance to lower your current loan rate. Rob Arnold, a real estate investor and broker at Sand Dollar Realty in Central Florida, contacted his bank this past week, and after talking with his lender, they agreed to rewrite the loan terms on two of his rental properties to a fixed rate of 4%. This helped him avoid having to pay closing costs or loan origination fees while securing a much lower rate than his original mortgage.

How the rate cut will affect ARM and HELOC mortgages

Adjustable-rate mortgages (ARM) and home equity lines of credit (HELOCs) will see a slightly lower interest rate immediately because they are tied to the prime rate, which is directly related to the Federal fund rate. So when the Fed rate is lowered, any borrowers with an ARM or HELOC mortgage should see some savings.

How the rate cut will affect real estate prices and returns

Typically, the lower the interest rate the more incentive there is to borrow money, thus promoting purchasing and spending. This would normally stimulate an economy and promote buying, pushing real estate prices higher. However, today's crisis and the outcome of the Fed rate cut may not produce a normal outcome.

Things are still very uncertain in the market. Each day is bringing new policies and changes to the financial market and operation of the economy. While the Fed's emergency cut desires to stimulate the economy, real estate activity has slowed in many places, and the number of default rates on investment properties, loans, rent, and mortgages is still unknown.

Only time will tell how this will play out in the long run, but for now, it's likely we'll continue to see mortgage rates stay around or just below 4%, and we'll see a relatively flat real estate market.

Over the next few weeks and months, it's likely mortgage rates will go lower. However, if defaults increase and banks become strapped for money, we could see an increase in mortgage rates as a means to try and recoup their losses.

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