DO INTEREST RATES REALLY MATTER?

What is the role of interest rates?

In a world where everything has to be measured, interest rates are the price assigned to the risk associated with lending. A borrower who displays higher risk potential will be charged higher rates in order to compensate for the potential loss that the lender will suffer in case of non payment. The recent lending practices illustrate this quite clearly: subprime borrowers were charged higher rates while people with good credit and verifiable income and assets enjoyed lower rates. Mortgage performance between these two groups backs the wisdom of the policy.



Current interest rates environment.

Since the middle of last year, interest rates have continued to decline. The 30 years mortgage is less than 6% for most conventional and FHA insured mortgages. During the same period despite the Fed policies, the number of foreclosures has increased significantly. Property values have also taken a hit. The combination of these factors tends to prove that interest rates are not the main factor in housing sales. People will borrow money and are willing to pay the prevailing rates as long as they get what they want. The policy of low interest rates that the Fed has embarked on does not appear to solve the housing slump issue. Declining property values, rising energy prices, massive lay-offs keep people from committing. In other words consumers are seen greater risks in borrowing regardless of the level of existing interest rates.



Breaking the cycle.

Low demand for new loans can only be reversed if consumers regain confidence in the economy. This will happen when consumers no longer feel threatened to lose their jobs, to see the equity in their homes disappear and when energy prices will stop taking a bigger chunk of their income.

Major banks have been reporting losses in huge amounts and the red ink is likely to continue in the next quarters. If this persists, the economy may fall into a recession and cutting interest rates will have little impact.

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