The Federal Reserve has slightly changed its promise regarding interest rates, and that minor change could have a major impact on the housing market. The announcement was made last week during the central bank's final Federal Open Market Committee meeting of 2012. The number of home sales and mortgage applications have increased in recent months, but not at the rate that the Federal Reserve would like to see. So they're hoping the change in their policy will boost those numbers.
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The Federal Reserve is constantly trying to stimulate the economy, and do so by affecting interest rates. Back in September, the Fed promised to keep short-term interest rates at near-zero until at least 2015, regardless of the economic climate. They are also attempting to keep long-term interest rates at near record lows by purchasing $40 billion a month in mortgage-backed securities – a program called Quantitative Easing. Right now, we’re in the third round of Quantitative Easing, so the policy is referred to as QE3. Leaders at the Fed claimed they would continue to QE3 for “a considerable time after the economic recovery strengthens.” They had hoped that would encourage investors to take part in more economic activity – like investing their money, hiring more workers, creating new businesses, etc. But critics of QE3 say that investors weren't convinced that the Federal Reserve would continue its low-rate stance at the first sign of recovery after that 2015 date. So, in an effort to calm those fears and convince investors that the central bank is in this for the long haul, leaders at the Federal Reserve added specific benchmarks to their policy. Instead of promising they would continue to purchase mortgage-backed securities until 2015, they are now saying that QE3 will continue until the national unemployment rate falls below 6.5% and/or the projected inflation rate gets above 2.5%. By giving specific benchmarks, the Federal Reserve is hoping that investors and consumers will trust their long-term commitment to the low-rate policy, and will begin to invest and/or spend more money.
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But, will it work?
Some say the change was unnecessary. That’s because record-low interest rates, coupled with uncertainty surrounding the fiscal cliff, has led to more mortgage applications and refinances in recent weeks. The Mortgage Bankers Association (MBA) reported last week that mortgage applications increased for the sixth straight week, and that refinances on existing mortgages was up 8%. They also reported that home purchases were up 1% and overall mortgage applications were up 10%, when compared to the same time frame last year. The average interest rate for 30-year mortgages ranged from 3.3 to 3.75%, depending on the size and type of loan. Economists at the MBA say they expect application numbers to increase as long as the interest rates stay low, but worry that the fiscal cliff may affect home sales. If lawmakers don't address the scheduled tax hikes and spending cuts in the coming weeks, the country's economy could slip back into a recession. At that point, even the new measures by the Federal Reserve may not be enough to stimulate the housing market. If another recession occurs, the unemployment rate will increase, and consumers will be less likely to apply for a mortgage during times of economic uncertainty.
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So, what does all this mean?
While the Federal Reserve's new promise is a big step, it alone is not enough to boost the economy and the housing market. The larger concern is the fiscal cliff budget crisis that politicians are trying to address in Washington. If they don't make decisions soon, the economy will spiral downward, and if that occurs, even QE3 will not be enough to resuscitate a housing market that is still recovering from the last recession. But, if lawmakers can keep us from falling over the fiscal cliff, the economy can continue to recover, and the housing market should also continue to make strides. That means QE3 may actually create its intended results.
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