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Mortgage rates are influenced by market factors and an applicant’s personal qualifications.
There are obvious personal factors like credit score and down payment amount and less obvious market factors like inflation and the role of the Federal Reserve.
What the Federal Reserve Does
The Federal Reserve, or the Fed, is an independent federal agency whose goals are to maintain maximum sustainable employment, steady interest rates, and price stability for goods and services in the U.S.
The Federal Reserve is our central bank, and it provides us with a safe, stable, and flexible financial system.
>> More: How Are Mortgage Rates Determined?
How Does the Federal Reserve Affect Interest Rates?
In addition to regulating and providing banking services to the banks that service us, the Fed manages inflation and sets national short-term interest rates. These duties are closely tied together, and they affect mortgage rates for everyday consumers.
The Federal Open Market Committee (FOMC) is the board within the Fed that sets monetary policy, specifically the target for the federal fund’s rates, which is the rate at which banks borrow and lend money overnight to each other.
This short-term interest rate influences the prime rate or the best possible rate mortgage lenders offer their top-tier customers.
The federal funds rate doesn’t directly affect the rate of a long-term loan like a mortgage, but the two typically move in the same direction.
The Fed also influences mortgage rates by trading mortgage-backed securities on the secondary bond market. Upon closing, lenders immediately sell mortgages to an investment bank or a government-sponsored entity like Fannie Mae or Freddie Mac to free up money for new potential home loans.
Mortgages with similar characteristics like applicant credit score, down payment, and loan term are bundled together and then sold to mortgage investors. These mortgage bonds are a safe investment compared to the stock market.
When investors have great interest in buying mortgage-backed securities, mortgage rates tend to increase.
On the contrary, when investors aren’t attracted to purchasing mortgage bonds, mortgage rates decrease to create demand in the housing market.
>> More: How Government Home Loans Work
Federal Funds Rate Explained
Through monetary policy, the Fed sets a target for the federal funds rate. Remember, this is the short-term interest rate commercial financial institutions employ when borrowing money overnight from each other to meet their reserve requirement.
The FOMC sets a target rate eight times a year. The federal funds rate influences primarily short-term interest rates, while long-term interest rates are impacted to a lesser degree.
Federal Reserve Cutting Interest Rates
In response to the coronavirus pandemic, the Fed has maintained its federal fund’s rate between 0 and 0.25 percent to help increase overall economic activity.
When banks can borrow money at a low rate, they pass lower rates onto their customers to remain competitive, and when consumers and businesses can borrow more cheaply, they will purchase more homes and employ more people.
In other words, when the Fed cuts its rate, online mortgage lenders typically follow suit to some degree.
Federal Reserve Raising Interest Rates
The Fed keeps inflation in check by raising interest rates. When rates are low and more money floating around in the economy, the overall price for goods and services increases. A rate increase stabilizes prices and reins in inflation.
Relationship between Fed Interest Rates and Mortgage Rates
It bears to mention again that the Fed does not set national mortgage rates. It influences all types of rates, just not at the same pace or proportion.
Federal Funds Rate and HELOCs
One of the short-term interest rates the federal funds rate directly affects is the prime rate—the rate banks and credit unions charge their best customers.
These are borrowers with excellent credit and a low debt-to-income ratio. Home equity lines of credit, or HELOCs, are tied to the prime rate, so when the federal funds rate moves, so do HELOC’s adjustable rates.
What Influences Mortgage Rate Movements
Specific market factors in addition to the overall health of the economy influence mortgage rate movements.
Inflation, unemployment, and the bond market are such factors. When the economy is doing well, characterized by higher inflation and lower unemployment, rates consequently trend higher, and the inverse is true.
When the economy is hurting, accompanied by lower inflation and higher unemployment, rates trend lower.
Finally, an increase in investor demand for mortgage bonds pushes mortgage rates lower, but instead, when investor demand is minimal, rates will increase to attract buyers. These are buyers of bonds, not buyers of homes who obviously want the lowest rate they can get.
Do Mortgage Rates Go Down When the Fed Cuts Interest Rates?
Mortgage rates are not guaranteed to decrease when the Fed cuts interest rates. In fact, they sometimes increase briefly, but they pretty much always eventually follow the Fed’s rate’s movements.
Short-term and variable-rate loans are affected earlier than long-term rates are, but those eventually catch up.
Bottom Line: How the Federal Reserve Affects Mortgage Rates
The Federal Reserve’s actions impact everyone, and since housing is a major aspect of our working economy, the Fed tries to maintain affordable housing by keeping mortgage rates relatively low.
Lately, they have been achieving this by purchasing billions worth of mortgage bonds every month.
We’ll keep you updated if major developments occur in the federal funds rate, the prime rate, and of course, the national mortgage average.