How will the Fed zero rate cut impact my mortgage?

First, what is the Federal Funds Rate? The Fed Funds Rate (FFR) is a short term loan interest rate offered to banks for borrowing money from the Fed. One of the intended consequences for lowering this rate is to spur banks to borrow money and increase their reserves. With an increase in reserve, banks are able to lend more because their reserves meet the amounts required to lend.

You may think this would have an impact on longer term mortgages, because if banks can lend more, why wouldn't they decrease their long term mortgage rates to drive refi's and more transactions?

If interest rates are artificially decreased, inflation may result. Inflation erodes the value of the fixed return received from the interest charged for the loan. So if the Fed Fund Rate (FFR) cut is viewed as inflationary, a bank offering long term loans is going to increase their long term rates to match inflation. This is done to protect the downside for their existing loan portfolio. For example, if the interest payment on an amortized loan is $1000, with inflation that $1000 is now worth $900 or less. Because of this impact on their existing portfolio, the bank has no incentive to lower interest rates on mortgage loans.

So what can the Fed use as an inflationary counter measure? The Fed is buying at least $700B in Treasuries and Mortgage Backed Securities (MBS) from banks. Purchasing these MBS, which are the loans the banks have made in the past and are now servicing will remove the loss of dollar value due to inflation.

This Quantitative Easings (QE) approach was taken in 2008 and resulted in keeping long term interest rates low and spurred banks to lend so companies could expand, create more jobs and fuel the economy.

While Quantitative Easing removes loans from a bank's balance sheet, banks are still servicing these loans. Servicing includes managing the account balance, sending statements, customer support and sending late payment letters. In return for servicing, the banks charge on average 40-60 BPS of the debt. Typically it takes a few years to become profitable based on the upfront investment required to service a loan. This is another reason banks have no incentive to decrease interest rates, new loans take time to reach servicing profitability and cramming twice the amount of loan originations through will require the banks to make an investment in servicing in uncertain times.

With so many unknowns, some banks are raising rates to slow the flow and retain a bit of margin. Hopefully this is temporary and once these refinances go through the pipeline, capacity will open up and rates can move lower. In addion, durng recenssionary periods, intreest rates fall. If we have not already entered one, with the impact of the coronavirus, we most likely will.