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The Prime Rate at One Bank Can Be Different from the Prime Rate at Another.

One caveat here: Mortgage loans based upon a bank's prime rate will be directly affected by the bank's own cost of funds. The prime rate is what banks charge their very, very best customers. While the Fed doesn't adjust a bank's prime rate, it adjusts the rate at which banks can lend money. The prime rate will always be higher than the discount rate and the fed funds rate.

The prime rate is defined by the Wall Street Journal (WSJ) as "The base rate on corporate loans posted by at least 75% of the nation's 30 largest banks." One bank's prime rate might be different from another bank's.

Loans that are based on a bank's prime rate are typically adjustable (like the index) mortgages. Equity loans and second mortgages are almost always of this type. We'll discuss equity lending in more detail in Chapter 8.

A Lender's "Secondary Department" Sets Mortgage Rates for Its Company.

Every single day, all day long, there is a department at a mortgage company that does nothing except watch the prices of various mortgage bonds to determine how the company will set its mortgage rates for the day. This department is called the secondary department of the lender, and every mortgage banking operation has one. It's this department that sets the rates that are distributed to the company's loan officers, who pass them along to you, the consumer.

As each business day opens, all of these secondary departments watch the opening trading of the various mortgage bonds. If the price of the 30-year Fannie Mae bond is selling on the open market at the same price as it was yesterday, then the rates for that day will be the same.

If the price of the bond goes up, the yield then goes down, meaning that rates get lower. If there is less demand for a mortgage bond, the yield goes up, raising mortgage rates. This goes on all day long. And mortgage prices change constantly.

Mortgage bonds are priced in basis points; 1 basis point equals 1/100 of 1 percent. As the price of a bond changes throughout the day, the secondary department must be alert for any price swings. If the price of a particular mortgage bond moves by just a few basis points, say three or four, there will be no change.

If, however, there is a move in price of, say, 15 or more basis points, you can expect the lender to make a price adjustment. Different lenders have different thresholds for price changes, but most will start to get nervous if a bond price has moved 15 basis points one way or the other. You can bet that if the bond price has changed by 15 or more basis points, there will be a midday rate change. This is why the rates seen in the newspaper, on the Internet, or in other advertisements mean little—they change.

The rates themselves generally won't change as much as the cost to the consumer will change. If 6.00 percent can be found at 1 discount point and mortgage bonds lose 50 basis points, that will typically mean an adjustment in the interest rate to 6.125 percent or cost you, the consumer, 1/2 discount point more in price. Don't confuse basis points with discount points. They're different.

Secondary departments watch mortgage bond pricing, and also watch for various economic and political events that might trigger a bond sell-off or a bond rally. Did the unemployment number show strong job gains? Then one can expect money to move out of bonds and into stocks. That means higher rates.

Economic events that point to a stronger or weaker economy will also affect interest rates throughout the day. So can political events.

Events at home or abroad can affect mortgage rates. Anything that could be interpreted as being a drag on the economy would portend lower rates. Is there uncertainty in any particular market? Then look for an economy that is not poised to move in one direction or the other. And in most cases, whenever there is uncertainty, stock markets move lower and more money is put into bonds.

Then again, economic or political news can have no impact on markets. Or conflicting news items can "cancel" each other out, keeping rates stable. Typically, rates won't have extended periods of wild swings. There will be some adjustments as market moods shift, but overall one won't be seeing constant, dramatic rate changes. But change they can, and that's why the rates you see advertised anywhere aren't reliable.

 
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