When the Fed lowers the federal funds rate, lenders can finance home loans more cheaply. As a result, they can reduce the interest rates they charge you for a fixed-rate mortgage. In recent years, the federal funds rate has been zero or near zero, as the Fed attempts to stimulate the housing market.
"The Fed is making homes affordable at all-time levels with low interest rates on mortgages," Mervine says. "A lot of people are underwater, but if they can save and pay down their prior mortgage, they can refinance at extremely low rates."
The Fed can even control the shape of the yield curve, or the relation between interest charged for one-year loans, three-year loans, five-year loans and so on. "If they want to bring down 10-year rates, they'll go out and buy 10-year securities," says Oghoorian.
Mortgages are pegged to the 10-year Treasury rate, because refinancings and early payoffs effectively give the 30-year mortgage a 10-year duration, Oghoorian says. Competition and market conditions also affect rates.