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The Federal Reserve raised interest rates by half a percentage point this week, closing out a year of historic increases. While the Fed does not set mortgage rates (and the central bank’s decisions don’t drive mortgage rates as directly as they do other products, like savings accounts and CD rates), key players in the mortgage industry keep a close eye on the Fed’s moves, and the mortgage market’s attempts to interpret the Fed’s actions affect how much you pay for your home loan.
What the Federal Reserve does
The Federal Reserve sets borrowing costs for shorter-term loans in the U.S. by moving its federal funds rate. The Fed kept this rate set near zero during much of the coronavirus pandemic. The rate governs how much banks pay each other in interest to borrow funds from their reserves kept at the Fed on an overnight basis.
Mortgages, on the other hand, track the 10-year Treasury rate. Changes to the federal funds rate might or might not move the rate on 10-year Treasury bonds, which are issued by the government and take a decade to mature.
The Fed also influences mortgage rates through monetary policy, such as when it buys or sells debt securities in the marketplace. Early in the pandemic there was severe disruption in the Treasury market, making the cost of borrowing money more expensive than the Fed wanted it to be. In response, the Federal Reserve announced it would buy billions of dollars in Treasuries and mortgage-backed securities (MBS). The move was to support the flow of credit, which helped push mortgage rates to record lows.
What influences mortgage rates
Fixed-rate mortgages are tied to the 10-year Treasury rate. When that rate goes up, the popular 30-year fixed-rate mortgage tends to do the same, and vice versa.
Rates for fixed mortgages are also influenced by other factors, such as supply and demand. When mortgage lenders have too much business, they raise rates to decrease demand. When business is light, they tend to cut rates to attract more customers.
Price inflation pushes on rates as well. When inflation is low, rates trend lower. When inflation picks up, so do fixed mortgage rates.
The secondary market where investors buy MBS plays a role, too. Most lenders bundle the mortgages they underwrite and sell them in the secondary marketplace to investors. When investor demand is high, mortgage rates trend a little lower. When investors aren’t buying, rates may rise to attract buyers.
The Fed’s actions do indirectly influence the rates consumers pay on their fixed-rate home loans when they refinance or take out a new mortgage.
What Fed rate decisions mean for mortgages
The Fed sets the federal funds rate. This is an interest rate applied to money that banks and other depository institutions lend to each other overnight.
The fed funds rate affects short-term loans, such as credit card debt and adjustable-rate mortgages, which, unlike fixed-rate mortgages, have a floating interest rate that goes up and down with the market on a monthly basis. Long-term rates for fixed-rate mortgages are generally not directly affected by changes in the federal funds rate.
What to consider if you’re shopping for a mortgage
When you’re shopping for a mortgage, compare interest rates and APR, which is the total cost of the mortgage. Some lenders might advertise low interest rates but offset them with high fees, which are reflected in the APR.
To begin your search, compare offers online, read lender reviews and go directly to lenders’ websites.
If you have a relationship with a lender, bank or credit union, find out what interest rate or customer discount you might qualify for. Often, lenders will work with existing customers to give them a better deal than they might otherwise get at another place.
Mortgage rates are on a rising track, so pay attention to the Fed and the economy and make sure to shop around so you get a rate that suits your budget and goals.