Home Buyers: A Borrowed Dime Grows More Costly

The Federal Reserve is widely expected to hold its key overnight interest rate steady at 5.25 percent when policymakers meet at the end of this month, and possibly through the rest of this year.

This rate, which has been steady for a year, is the benchmark for short-term rates such as those charged on credit cards and on many business loans, and those paid by banks to holders of certificates of deposit. These rates have not moved up in recent weeks.

Longer-term rates are influenced by the Fed but ultimately are determined by global capital markets, which are influenced by the changes in the supply of and demand for money and by investors' expectations for growth and inflation.

For example, a common benchmark, the yield on the 10-year Treasury note, reached 5.32 percent at one point last week, the highest level since April 2002 and up significantly from a low of 4.497 percent in early March. The yield fell Friday to 5.17 percent, after the Labor Department reported that inflation, excluding food and energy, was mild last month.

Long-term rates hit their lows in early March on fears of a recession. Pessimism peaked after the Dow Jones industrial average plunged more than 400 points in late February. Bankers also reported rising rates of home foreclosure and late mortgage payments, and many signs indicated economic growth had slowed to a crawl in the first three months of the year. Many bond traders bet a weakening economy would depress the demand for capital and prompt the Fed to cut short-term rates to stimulate growth.

Bad bet. Instead, the opposite occurred. The economy has rebounded, with retail sales, factory production and job growth all picking up in recent months, while unemployment remains low.

And instead of hinting at a rate cut, the Fed has emphasized its inflation worries.

The recent pop in rates shows "the bond market is finally realizing the Fed isn't going to cut rates this year," said Dean Junkans, chief investment officer of Wells Fargo Private Client Services.

Meanwhile, strong economic growth has fueled inflation pressures worldwide, prompting the central banks in Europe and New Zealand to raise interest rates two weeks ago. Analysts expect the European Central Bank and its counterparts in Britain, Japan and perhaps China to raise their rates in coming months, tightening the supply of money.

Rising rates appear less upsetting to borrowers who remember buying their first homes when 30-year rates were more than 7 percent or even in double digits during the 1970s and 1980s, Foley said. More recent home buyers are less accepting, he said. "I think we got spoiled by these rates in the 6's."