How the Federal Reserve Affects Mortgage Rates

Home buyers today are very focused on interest rates, but many times they have no idea what affects these rates and causes them to go up or down.

What does the Federal Reserve do?

The Federal Reserve was created by the 1913 Federal Reserve Act to manage U.S. monetary policy and stabilize the economy. It includes 12 regional banks and 24 branches, overseen by a board of governors who are also members of the Federal Open Market Committee (FOMC). The FOMC sets the interest rate banks use to borrow and lend.

When inflation rises, the Fed increases interest rates to make borrowing more expensive and slow down the economy. Banks then raise rates on loans like mortgages. In economic downturns, the Fed lowers rates to encourage spending and boost growth.

How does the Fed impact mortgage interest rates?

The Federal Reserve doesn’t directly set mortgage rates, but it affects them by adjusting the federal funds rate, which is the interest banks charge each other for short-term loans. These changes impact the cost of borrowing, leading to shifts in mortgage rates and the housing market.

“When the Fed raises rates to slow the economy, sectors like tech, finance, and housing are usually hit first. It’s important to follow what the Fed does because its decisions can influence things like credit card interest rates, savings account yields, and even stock market performance.

Economic factors that impact mortgage rates

• Policy changes from the Fed: When the Fed adjusts the federal funds rate, it spills over into many aspects of the economy, including mortgage rates. The federal funds rate affects how much it costs banks to borrow money, which in turn affects what banks charge consumers to make a profit. 
• Inflation: Generally, when inflation is high, mortgage rates tend to be high. Because inflation chips away at purchasing power, lenders set higher interest rates on loans to make up for that loss and ensure a profit.
• Supply and demand: When demand for mortgages is high, lenders tend to raise interest rates. The reason is because lenders have only so much capital to lend out in the form of home loans. Conversely, when demand for mortgages is low, lenders slash interest rates in order to attract borrowers. 
• The bond market: Mortgage lenders peg fixed interest rates, like fixed-rate mortgages, to bond rates. Mortgage bonds, also called mortgage-backed securities, are bundles of mortgages sold to investors and are closely tied to the 10-Year Treasury. When bond interest rates are high, the bond has less value on the market where investors buy and sell securities, causing mortgage interest rates to go up. 
• Other economic indicators: Employment patterns and other aspects of the economy that affect investor confidence and consumer spending and borrowing also influence mortgage rates. For example, a strong jobs report and a robust economy could indicate greater demand for housing, which can put upward pressure on mortgage rates. When the economy slows and unemployment is high, mortgage rates tend to be lower.

Personal factors that impact mortgage rates

The specific factors that determine your particular mortgage interest rate include:

• Your credit score.
• The home’s location.
• The home’s price.
• Your down payment.
• The loan amount.
• The loan type and term.
• The type of interest rate.

The bottom line

When the Federal Reserve adjusts the benchmark interest rate, it indirectly affects mortgage rates. The Fed’s rate cuts will help home loan rates improve, though it won’t be dramatic or immediate. Mortgage rates will also respond to inflation, investor expectations and the broader economic outlook. Experts predict that mortgage rates should continue going down in the last months of 2024.