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How the Federal Reserve System Impacts Mortgage Rates

One of the biggest factors your lender takes into consideration is the fund rate set by the Federal Reserve System. Although this rate isn’t applied directly to mortgages, it does have an impact on your mortgage rate.

Interest rates vary depending on values such as the health of the housing market, local property values, and interest rates set by each independent lender. Those interest rates are determined in part by the risk of the loan but also by the Federal Reserve System.

The Federal Reserve System doesn’t set interest rates, but it does regulate credit value, which impacts mortgages. Understanding this relationship between the government and lenders will help you understand how your mortgage rate is determined and what constitutes a reasonable interest rate.

What Is The Federal Reserve System & What Does It Do?

To understand how the Federal Reserve System affects mortgage loans, let’s take a step back and look at the role it plays in regulating our national economy.

What Is The Federal Reserve System?

The Federal Reserve System is the United States’ central bank and created with the purpose of maintaining a healthy U.S. economy. Its goals are to encourage economic health while curbing inflation whenever it can. It does this in two ways: setting target interest rates for short-term mortgages between banks and putting money into the economy to promote growth (commonly referred to as open market operations).

What Does The Federal Reserve System Do?

The Federal Reserve System duties can be categorized in 4 ways.

  1. Setting monetary policies by influencing monetary and credit conditions to ensure maximum financial stability.
  2. Overseeing and regulating banks to ensure the stability of the U.S. financial system and protect consumers.
  3. Provide payment services to banks, national payment systems, and more.
  4. Maintaining financial stability of markets and operations and works to prevent potential financial crises.

The Federal Open Market Committee (FOMC) meets eight times each year to review the federal fund rate. Most meetings don’t result in a fund rate change, but during periods like the Great Recession in 2007 and 2008 and during the 2020 COVID-19 pandemic, the FOMC has dropped interest rates and injected capital into banks and other initiatives.

Why Does The Federal Reserve System Raise Or Lower Rates?

The Federal Reserve System lowers the fed funds rate to help promote economic growth in the country. If it sets low target interest rates on short-term investments, mortgage rates will typically follow.

The Federal Reserve System will raise interest rates in an effort to curb inflation and limit the number of buyers and borrowers. This incentivizes investors to buy mortgage bundles from lenders, who can then offer more affordable rates on mortgage loans.

What Is The Current Federal Funds Rate?

Let’s discuss what the Federal Funds rate is and how it works.

What Is The Federal Funds Rate?

The federal fund rate controls the interest rate charged to banks for borrowing money from each other, which they need to meet national requirements.

The fund rate directly affects short-term loans that banks offer to customers, like personal loans or lines of credit. This, in turn, impacts investors who buy mortgages from lending companies, which affects the interest rates that the lender then charges to borrowers.

Do Mortgage Rates Follow The Fed Rates?

While mortgage rates generally follow the fed rates, they are not set by the Federal Reserve System. As we mentioned before, the fed fund rate attempts to control inflation, which protects the health of long-term loans like mortgages. Investors and lenders closely follow the fed rate to guide their financial decisions, especially with fixed-rate loans that have a locked-in interest rate.

What Is The Rate Currently At?

In March 2020, the FOMC set the federal fund target rate at 0-.025%, an all-time low.

With historically low loan rates this may be a great time to refinance your mortgage or shop for a new home.

Impact Of Rising Rates

When the Federal Reserve System raises the interest rates charged for banks to borrow money, it’s likely that their customers will get higher interest rates. Keep in mind that the fund rate only affects short-term loans, there’s a trickle-down effect towards longer-term mortgages as well.

Lenders will also set interest rates to accommodate for the chances of inflation and increasing interest in the future. If the Federal Reserve System raises its rates to account for inflation, lenders will raise interest rates on fixed-rate mortgages. This is an example of the indirect effect of the fed fund rate.

In Conclusion

Like many moving parts of economics, the relationship between the Federal Reserve System and your home mortgage is more an art than a science. It depends on government forecasts and initiatives but also on the calculations of individual lenders who are carefully watching other banks and investors around them.

While understanding the ebb and flow of fed rates is difficult, it’s helpful when buying a home to have a basic understanding of how the current economic climate affects your mortgage rate.

 

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All material is presented for informational and educational purposes only and should not be construed as individual financial, investment, or legal advice or instruction. ZeroMortgage does not guarantee the quality, accuracy, completeness or timelines of the information in this publication. While efforts are made to verify the information provided, the information should not be assumed to be error free. Some information in the publication may have been provided by third parties and has not necessarily been verified by ZeroMortgage. ZeroMortgage, its affiliates, and subsidiaries do not assume any liability for the information contained herein, be it direct, indirect, consequential, special, or exemplary, or other damages whatsoever and howsoever caused, arising out of or in connection with the use of this publication or in reliance on the information, including any personal or pecuniary loss, whether the action is in contract, tort (including negligence) or other tortious action. ZeroMortgage does not provide tax advice. Please contact your tax adviser for any tax related questions.

This page last updated: May 12, 2022