Homes in St. Peters and St. Charles Mo.

The Federal Reserve has cut interest rates six straight times since September 2007. Most analysts are predicting that the Fed will cut rates even further when it meets at the end of this month. And yet, despite a full 3% in interest rate cuts during this time, mortgage rates are significantly higher now than they were just three months ago. How is that possible? Don't rate cuts equal lower mortgage rates?

Here's the straight story: Mortgage interest rates are dictated by one thing and one thing only — the performance of mortgage-backed securities. Despite what you may have heard in the media, interest rate cuts from the Federal Reserve have no direct effect on long-term mortgage rates.

The True Role of the Federal Reserve
The Federal Reserve, our nation's central banking system, was put in place to help avoid major financial collapses like the Depression. The Fed has two specific duties: to keep inflation in check and regulate the nation's financial institutions. And while it has some regulatory power over how the mortgage industry operates, in its 95-year history, the Federal Reserve has never once set or reset mortgage interest rates. It simply has no authority to do so.

But, to control inflation, the Fed has several tools at its disposal, including the ability to adjust the Discount Rate and the Fed Funds Rate, which are very different from mortgage interest rates. By increasing or decreasing these interest rates, the Fed can manage inflation and economic growth according to its financial policy. While movement in these interest rates does affect the Prime Interest Rate – which directly affect things like credit cards, home equity lines of credit (HELOCs), and adjustable-rate mortgages – long-term mortgage rates do not always follow suit.

In the following chart, mortgage rates are shown to have actually increased from March 2007 to March 2008, even though the Federal Reserve cut interests rates six consecutive times, slashing three full percentage points in the process.

What Really Moves Mortgage Rates?
Mortgage rates are set daily by individual lending institutions and are based solely on the trading activity of mortgage-backed securities (MBS), a type of bond that investors trade daily.

Without getting too technical, MBS are bonds that represent mortgages currently in place. For instance, let's say you have a 30-year fixed rate mortgage of $200,000 at an interest rate of 6%. That loan isn't worth anything right now, but over a 30-year period, it represents a profit of 6% or up to $12,000 every year for the bank that owns the loan, provided you make all of your payments.

However, instead of waiting 30 years to collect on that profit, your loan is "sold" to a bank where it is bundled together with other similar loans. It's like winning the lottery and choosing the cash value prize instead of accepting full payments that are spread over 20 years. Of course, you get less money than the total value of the prize if you choose the cash upfront, but you don't have to wait twenty years to collect it all.

This group of bundled loans then, just like a public company, is split into smaller units or bonds and sold just like stocks in a company to investors. These bonds, secured or backed by the profits from the loans, are called mortgage-backed securities. And just like stocks, investors like you and me can buy and sell them every day.

And it's the performance of these specific bonds that lending institutions use to set mortgage rates.

The real dynamic at the heart of interest rate movement, then, is the complex relationship between stocks and bonds, supply and demand, inflation, news that moves markets, the economy, employment levels, political events, gross domestic product, and any number of other factors.

And while there exist a number of somewhat reliable economic indicators, if anyone tells you that he or she has the secret formula for predicting these movements exactly, it's just not true. There is no magic formula, no index, no rate cuts or Fed activities that work 100% of the time.

As a real estate professional, I try to keep informed about the items that bear on our industry.  Most importantly I rely on my experiences with the professionals that we need.  In this case ask me to help you find the mortgage professional that will best service your needs.