SANTA CRUZ (January 27, 2008) - In an unexpected and highly unusual move, the Fed dropped the Fed Funds Rate by 3/4 of a percent to help the U.S. economy recover from a one-two punch delivered by high oil prices and the mortgage meltdown. The Fed met in an emergency meeting after the dramatic stock market plunges in the European and Asian markets on the Monday our markets were closed in honor of Martin Luther King jr. The Fed’s move was intended to stave off a similar plunge in our stock market, which it did do. Banks immediately followed the Fed’s move with a 3/4 percent drop in Prime Rate, to 6.5 percent, which is the rate that many home equity lines of credit and credit cards are indexed to.

Normally, by the time the banks announce that prime rate has moved, as they did on Tuesday, long term mortgage interest rates have already made their move. The buzz among economists for the past several weeks has been all about what Ben Bernanke and the Fed would do with interest rates at their meeting at the end of this month.

Once again most Fed watchers had come to the conclusion that the only unknown in advance of the January meeting was whether the Fed would cut rates by one quarter of a percent or one half of one percent. Mortgage-backed securities (the driving force behind mortgage interest rate movements) have been trading higher, bringing long term mortgage rates down, in anticipation that the Fed would drop rates to combat a slowing economy.

The Fed cut the Fed Funds Rate from 4.25 percent to 3.50 percent. The lower rates will not only help out home owners who have adjustable rate mortgages, equity lines of credit and credit card debt but it will also encourage consumers to spend and corporations to borrow and expand and hire more employees, which is all good for our economy.

The Fed rate moves have a direct influence over short term interest rates such as prime (which is traditionally set at 3 percent above the Fed Funds Rate) and adjustable rate mortgage indices such as one and three year treasuries but little or no long term effect on 15 and 30 year fixed mortgage rates. In fact, historically, just after the Fed makes a cut, fixed mortgage rates often are rising.

The surprisingly large rate cut this week sparked a brief and dramatic rally in mortgage-backed securities which lowered fixed mortgage interest rates to levels not seen for 40 years. Although we saw 30 year fixed rates for conforming loans drop below 5 percent for a few hours on Wednesday, rates may remain in the 5 - 5.5 percent range for a while. This presents an excellent opportunity today for homeowners with adjustable rate mortgages as well as those with fixed rate mortgages to refinance into a lower rate.

Prospective home buyers and refinancing home owners may be disappointed if they wait for yet lower rates. I suggest you take action, call your mortgage professional and find out what rates and what options are available to you. On the downside, home values may have fallen and mortgage guidelines have changed dramatically. These changes will prevent many homeowners from being able to take advantage of this opportunity.

Mortgage rates on ‘jumbo’ loans, loan amounts over $417,000 for single family residences, are still about one full percent above the rates on ‘conforming’ loans, which are loans under $417,000. This is due in part to the lack of confidence bond investors have in the larger loans, following the mortgage meltdown last year.

To help borrowers, Congress is considering an increase in the FHA loan limit to $417,000 and an increase in the conforming loan limits to $625,500 in California (with the support of Governor Schwarzenegger), which would match the limits of the other two ‘high-priced’ states of Alaska and Hawaii. Although an increase in the conforming limit will probably will be temporary, it will be a huge benefit to California homeowners who will be able to consolidate 1st and 2nd mortgages and shave 1 percent or more off of their mortgages. Conforming loans not only offer lower rates but also easier underwriting guidelines.

This column is written every Sunday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 or email him at Peter@SantaCruzHomeFinance.com.