How the Federal Reserve impacts mortgage rates

3 min read

The Federal Reserve does not set mortgage rates, and its rate decisions don’t impact what happens to mortgage rates as directly as they do other products like savings account and CD rates.

But 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 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 is set to meet Wednesday to discuss the funds rate, which is currently set near zero. 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, tend to track the 10-year Treasury rate.

Changes to the federal funds rate may or may not move the rate on the 10-year Treasury, which are bonds issued by the government that mature in a decade. Though a Fed rate cut doesn’t directly push down yields on the 10-year, it can lead to the same outcome. Investors worried about the economy after a rate cut might flock to the 10-year Treasury, considered a “safe-haven” asset, pushing down yields.

The Fed also influences mortgage rates through monetary policy, such as when it buys or sells debt securities in the marketplace. In early March, for example, the pandemic caused 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 purchase billions of dollars in Treasuries and mortgage-backed securities, or MBS. The move was to support the flow of credit, which helped push mortgage rates to record lows in the days and weeks that followed.

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 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 mortgage-backed securities plays a role. 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.

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 conventional 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 affected by changes in the federal funds rate.

At this point, if the Fed wanted to reduce rates again to stimulate the economy, it would have to push rates into negative territory, a move that Fed Chairman Jerome Powell has said is not being contemplated.

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 customers to give them a better deal than they might otherwise get at another place.

Mortgage rates are at historic lows, so while you can and should pay attention to the Fed and the economy, your best move if you need a property loan is to get a rate that suits your budget and goals rather than trying to wait for rates to fall even more.

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