Fed keeps shoving interest rates lower

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The Federal Reserve continued its campaign to lower interest rates Tuesday and make consumer loans more affordable.

The Fed's rate-setting committee cut what it charges commercial banks for overnight loans by a quarter point -- the third reduction in four months.

By making it cheaper for banks to borrow money, the Fed hopes banks will lower the rates they charge all of us to borrow money for everything from homes and cars to holiday gifts and travel.

But how much further can we reasonably expect mortgage rates to fall?

Despite what you've heard about the mortgage crisis, the great majority of borrowers are already finding the money they need at very reasonable rates.

The average cost of a 30-year, fixed-rate loan fell to 6.0% -- the lowest it's been since September 2005 -- in Interest.com's latest weekly survey of major lenders taken Dec. 5.

Our extensive database of the best mortgage rates from across the country shows lenders offering 30-year loans for as little as 5.75% with fees of $1,000 or less.

You'd pay $600 a month in principal and interest for every $100,000 borrowed at the average rate, and $584 if you qualified for a 5.75% loan. (Interest.com's mortgage calculator can tell you what the payments would be for any loan at any interest rate.)

Those interest rates and payments are very reasonable when you consider what mortgages cost over the past couple of decades.

Home buyers routinely paid 7% or 8% during the mid- to late-'90s, and double-digit rates were the norm throughout the '80s and early '90s.

The only time mortgages were cheaper than they are now was four years ago, when 30-year rates briefly bottomed out at an average 5.28% -- the lowest they've been since Interest.com (and its print predecessors) began its weekly survey of major lenders in 1985.

All of the turmoil you've heard about -- lenders going out of business, banks and investors losing hundreds of billions of dollars, thousands of employees being laid off, soaring foreclosure rates -- is very real.

But that crisis has hurt only two types of borrowers:

Here's why:

Banks and finance companies obtain much of the money they loan for mortgages from two government-chartered companies -- commonly referred to as Freddie Mac and Fannie Mae -- or large private investors such as retirement plans, hedge funds and insurers.

Those investors panicked at the prospect of billion-dollar losses because a growing number of homeowners are defaulting -- primarily borrowers with poor credit who were given dangerous, adjustable-rate mortgages.

By early 2009 more than 2 million ARMs given to borrowers with credit scores below 700 will have reset to higher interest rates, pushing payments up by 30% to 100%. That's more than many of those homeowners can afford.

Almost everyone blames this mess on lax lending standards and a screwed up system that rewarded mortgage brokers for pushing loans that borrowers had little or no chance of repaying.

As a result, private investors have stopped providing money for virtually all types of mortgages.

The best bet for anyone with bad credit is a government-backed loan program.

Since Freddie Mac and Fannie Mae aren't allowed to buy mortgages for more than $417,000, jumbo loans have become more costly and difficult to get as well.

The average 30-year jumbo loan is down from a high of 7.5% this summer, but is stubbornly stuck above 7%, three-quarters of a point higher than this time last year.

What about ARMs?

Our survey found the average cost for 5/1 ARMs -- a 30-year loan with an initial rate guaranteed for five years and resetting each year after that -- is now 6.1%.

That's a little more than those loans cost in December 2006.

But the major reason borrowers opt for an ARM is to get lower monthly payments -- at least for a few years -- than with a fixed-rate loan.

With the average fixed-rate loan costing less than the average ARM, we urge you to go for fixed-rate financing. You'll know you've got a loan you can afford and never lose a night's sleep worrying about higher house payments.

The Federal Reserve is doing what it can to get the country through the subprime mortgage crisis by making borrowing cheaper.

It acts as the nation's super bank, lending money to all the commercial banks we deal with every day. When the Fed lowers its rates, those banks can obtain the money they need for consumer loans more cheaply.

But that doesn't mean rates for all types of consumer loans immediately follow suit, or decline as much as the Fed would like.

It's actions always have a bigger, more immediate impact on short-term loans. Other factors, such as inflation and stock market trends, play a larger role in the pricing of long-term loans such as mortgages.

The average cost of a 30-year fixed-rate mortgage has dropped a half-point since the Fed began reducing rates in September. But we're skeptical that it will fall much further even though the Fed has now lowered its rates by a full point.

The National Association of Realtors and Freddie Mac are projecting those loans will cost an average of 6.5% next year. So they clearly don't expect the Fed's efforts to push mortgage rates any lower.

But lets enjoy the undeniable trend while we can -- most borrowers are paying less for home loans.

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