The Fed Funds rate, set forth by the Federal Reserve, is the short-term interest rate offered for banks to borrow money amongst themselves. For instance, if Bank A has a lot of cash on hand and no demand or use of it, it loans that money to Bank B (through coordination with the Federal Reserve) which may in turn loan it to John Q Business or Citizen. The Federal Reserve is the clearinghouse for these activities. By reducing the Fed Funds rate on Sunday, the Federal Reserve hopes that BANKS will borrow more and in turn loan that money out into the marketplace, which will help the overall economy and keep businesses afloat during this downturn.

The glaring misconception by most people is that residential mortgage money comes from banks. The truth is, in most cases, a bank only temporarily funds a mortgage for a week or two, and the long-term funds are provided by investment made in bonds that are backed by mortgages.

Here is an example to simplify it:

Mr. and Mrs. Smith have saved up funds and are looking for an opportunity to make money on their money.

They consult with a financial adviser and choose to invest their funds into mortgage-backed bonds because they have reviewed other options for investing and the returns being paid from them. The Smiths could buy stocks, they could buy gold, oil, get a Certificate of Deposit or put the money in a coffee can. Taking into consideration all their options, they decide that they are willing to invest in mortgages if they can earn 3.0% on their money.

Mr. and Mrs. Jones have saved up some money and are now ready to buy a home and will need a mortgage loan.

They consult with their local mortgage broker or banker and get advice and guidance on the types of loan programs and the rates and costs associated with getting a mortgage. They decide they will go with a 3.5%, 30-year fixed rate loan. They go through the approval process and their mortgage broker/banker gets funds to their closing table. They walk out of the closing with the keys to their house.

Behind the scenes, a mortgage banker used a line of credit to temporarily fund this loan and then as soon as all of the post-closing details and documents are filed and finished, the mortgage banker sells the loan to an investment company that will take over the processing of the payments and in turn send the interest payments to Mr. and Ms. Smith. This frees up space on the line of credit to fund more loans.

What can be confusing here is that some banks do have a mortgage department. Although they offer mortgage products, their process is the same and they sell the mortgages they make just like mortgage brokers and mortgage bankers.

Everyone is happy because there is an efficient market here that keeps money flowing through the system. This is unlike the 1960s and 1970s when banks and savings and loan institutions made long-term loans based on the deposits and capital they had in their businesses. That did not work out very well in the late 1970s, when banks were holding loans that they had made in the 1960s with charged interest rates in the area of 5%, yet depositors were demanding 15%-plus on their deposits. The way a bank pays depositors is by making money on loans.

When someone says, “The bank is so greedy, why won’t they let me skip a payment or modify my loan?”, they are actually first showing a lack of knowledge and second saying Mr. and Mrs. Smith are greedy. Mr. and Mrs. Smith could be ME, or YOU or YOUR grandparents or the Teacher’s Retirement Fund of Georgia relying on the income from the investment(s) that made in the mortgage market. It’s not as simple as it seems.

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Mary Ansley Southerland is the owner of Marietta’s W.D. Little Mortgage and has worked as a loan officer for nearly 35 years.

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