Image courtesy of Getty Images, Illustration by Hunter Newton/Bankrate
The Federal Reserve doesn’t directly set mortgage interest rates, but its decisions influence the rates that lenders offer to prospective homebuyers, and mortgage rates can change even if the Fed keeps rates steady.
So, overall, how do the Fed’s monetary policy moves affect mortgages and how will they affect the borrowing costs to buy your dream home? Here’s how it works.
Federal Reserve Activities
The Federal Reserve Board has set the borrowing cost for short-term loans at Federal Funds RateThis rate determines how much interest banks pay each other when borrowing funds from reserves that are held overnight at the Fed.
The Fed raised this key interest rate in 2022 and 2023 to quell inflation, but the increases made it more expensive for Americans to borrow money and access credit.
Fixed Rate Mortgages The interest rates on most common mortgages do not reflect the federal funds rate. 10-Year Government Bond Yield (More on this below.) The federal funds rate affects short-term loans like credit card interest rates and mortgage interest rates. New mortgages and lines of credit.
of The Fed also buys and sells bonds in the money markets, which helps support the flow of credit and tends to have an aggregate effect on mortgage rates.
Federal Reserve’s latest meeting
At its September 18 meeting, the Federal Open Market Committee (FOMC) decided to cut interest rates by 0.50 percentage point, the first rate cut since the start of the COVID-19 pandemic. “Taking into account inflation developments and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 0.5 percentage point, to 4-3/4 to 5 percent,” the Fed said in a statement.
The cut came much later than expected at the start of the year. But with the economy continuing to perform well and inflation remaining elevated, the Fed left rates unchanged for the eighth consecutive time. Recent indicators of rising unemployment and subsiding inflation prompted the Fed to act. “The Fed cut rates by half a percentage point right at the start, and its economic outlook summary forecasts higher unemployment and lower inflation than projected just three months ago,” said Greg McBride, CFA, chief financial analyst at Bankrate. “This should continue the downward trend in mortgage rates.”
As for the coming months, Fed Chairman Jerome Powell said at a press conference that the decision to make further rate changes would be made “on a meeting-by-meeting basis.” However, published forecasts indicated that many board members expect the federal funds rate to fall further, reaching a range of 3.1% to 3.6% in 2025. “The Fed’s decision to cut the rate by half a percentage point is the beginning of six to eight further rate cuts through 2025,” Lawrence Yun, chief economist at the National Association of Realtors (NAR), said in a statement. He believes “further declines in mortgage rates will be minimal,” but predicted that “consumers who were unable to obtain mortgages due to previous high mortgage rates may return to the market.”
Factors that affect mortgage interest rates
Fixed-rate mortgages are tied to the yield on the 10-year Treasury bond, so if Treasury yields rise or fall, the interest rate on your fixed-rate mortgage will follow.
However, fixed mortgage rates are not exactly the same as 10-year rates. gap Between the two.
Typically, the difference between the 10-year Treasury yield and the 30-year fixed mortgage rate is 1.5 to 2 percentage points. For much of 2023 and 2024, that gap has widened to 3 percentage points, raising the cost of mortgages.
Mortgage interest rates fluctuate for a number of reasons, including:
- inflation: Generally, as inflation rises, fixed interest rates also rise.
- Supply and Demand: When mortgage lenders have too much business, they will raise interest rates to reduce demand. When they have less business, they tend to lower interest rates to attract more customers.
- of Secondary mortgage marketWhen an investor buys a mortgage-backed security: Most lenders bundle the mortgages they underwrite and sell them to investors on the secondary market. If investor demand is high, mortgage interest rates will be a little lower. If investors aren’t buying, interest rates may rise to attract investors.
How the Fed is Impacting Adjustable Rate Mortgages (ARMs)
Fixed-rate mortgages dominate the U.S. mortgage market, but some Americans prefer adjustable-rate mortgages, or ARMs, which have interest rates that reset annually or semi-annually. The Fed’s move could have a more direct impact on these mortgages.
More specifically, ARM interest rates are often tied to the Secured Overnight Financing Rate (SOFR). Because the Fed’s interest rate decisions are the benchmark for savings vehicles, an increase or decrease in the federal funds rate can cause the SOFR to rise or fall. ARM interest rates will similarly rise or fall when interest rates reset.
This means that if the federal funds rate increases, your ARM interest rate will also increase at the next adjustment.
Things to consider when taking out a mortgage
Regardless of current Federal Reserve policy, Lowest possible mortgage interest rates It’s important to maintain solid credit, keep your debt low, make as large a down payment as possible, and shop around for loan offers.
When comparing rates, look at the APR, not just the interest rate. Some lenders advertise low interest rates but offset them with higher fees. Understanding the APR will help you understand your true total cost, including these fees.
Conclusions on the Fed’s impact on mortgage rates
The Federal Reserve does not determine fixed mortgage rates. However, its policy decisions are factored into broader economic conditions that determine and affect borrowing costs. In setting fixed rates, mortgage lenders consider factors such as the 10-year Treasury yield, inflation, and investor appetite, in addition to the Federal Reserve’s actions. And when the Federal Reserve changes its benchmark borrowing rate, it also affects the index that affects ARM interest rates.
