Filed under: Bear Stearns Cos (BSC), Housing, Federal Reserve

Fed rate cuts help people who hold adjustable rate mortgages (ARMs) but they’re less valuable to people seeking new mortgages.

That’s because ARM rates reset periodically — e.g., every year — based on an index plus a lender’s margin — the amount a lender adds to the index, usually two percentage points or four percentage points, to set the actual interest rate of the ARM. The most common index for ARM adjustments is the one-year U.S. Treasury bill.

Last Friday, the one year treasury rate was at 1.88% — down 3.04 percentage points below the 4.92% rate it was at in April 2007. The Fed’s rate cutting has lowered the rates at the reset periods for those who already have adjustable rate mortgages. So a person who paid 2% plus the 1-year t-bill rate in April 2007 would have paid 6.92% during the last year and enjoyed a reset to 3.88% as of last week.

But the 5/1 ARM which currently averages at 5.58% was 5.91% in April 2007. This suggests that the Fed’s interest rate cuts have not had that much of an effect on mortgage rates for those seeking a new mortgage. The Fed’s rate cutting will continue to help people depending on what rate they are paying now and what the one year T-bill rate is at the next reset.

But many expect the Fed to stop cutting rates effective today for some time unless there is another market crisis along the lines of the collapse of The Bear Stearns Companies (NYSE: BSC). If rates are the same a year from now, obviously those people whose rates adjusted today will pay the same rate from April 2009 to the next adjustment period.

Who knows what the Fed will do next? It doesn’t have much more room to cut rates but I have no doubt that in the event of another capital markets crisis it will slash rates again and flood the market with more liquidity. This pattern will continue until January 2009 at which point the trajectory will depend on who occupies the White House.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in Bear Stearns securities.

Share This

This entry was posted on Tuesday, May 6th, 2008 at 1:12 am and is filed under Real Estate and Housing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.