How the Federal Reserve Impacts Mortgage Rates

The Federal Reserve’s interest rate bumps over the last two years helped push average mortgage rates into unaffordable territory, leaving prospective buyers on the sidelines and keeping the housing market immobilized.

Since last summer, the Federal Open Market Committee has kept the federal funds rate steady at between 5.25% and 5.50%. If interest rates stay higher for longer, that doesn’t bode well for homebuyers. Though the Fed outlined a plan to lower interest rates at least three times this year, inflation hasn’t yet proven to be on a steady downward trend toward the central bank’s 2% annual target. 

The Fed has to be confident that cutting borrowing rates won’t accelerate economic growth and drive up costs again, said Alex Thomas, senior research analyst at John Burns Research and Consulting. “While inflation is elevated, job growth is strong, real wages are rising and the stock market is near all-time highs, there’s no reason to rush [rate cuts],” Thomas said. 

Future economic data will play a major role in determining when — and by how much — the Fed cuts rates. Here’s what to know about how the government’s interest rate policy affects mortgage rates. 

Read more: What Recent Inflation Data Means for Mortgage Rates

What does the Federal Reserve do?

The Fed was established by the 1913 Federal Reserve Act to set and oversee US monetary policy to stabilize the economy. Consisting of 12 regional banks and 24 branches, it’s run by a board of governors who are voting members of the Federal Open Market Committee. The FOMC sets the benchmark interest rate at which banks borrow and lend their money. 

In an inflationary environment like today’s, the Fed uses interest rate hikes to make borrowing money more cost-prohibitive and slow economic growth. Banks typically pass along rate hikes to consumers in the form of higher interest rates for longer-term loans, including home loans. 

How does the federal funds rate impact mortgage interest rates? 

While the Federal Reserve doesn’t directly set mortgage rates, it influences them by making changes to the federal funds rate, the interest rate that banks charge each other for short-term loans. The Fed’s decisions alter the price of credit, which has a domino effect on mortgage rates and the broader housing market. 

“When the Fed raises interest rates to slow the economy, rate-sensitive sectors like tech, finance and housing typically feel the impact first,” Thomas said.

It’s important to keep an eye on what the Fed does: Its decisions can affect your money in multiple ways, including the annual percentage rate on your credit cards, the yield on your savings accounts and even your stock market portfolio.

What factors affect mortgage rates?

Mortgage rates move around for many of the same reasons home prices do: supply, demand, inflation and even the employment rate. Additionally, the individual mortgage rate you qualify for is determined by personal factors, such as your credit score and loan amount.

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:

When will the Fed start cutting interest rates? 

Housing market authorities predict mortgage rates will start to inch lower in the coming months. Even though economic data shows signs of progress, the Fed won’t consider cutting rates until it feels confident that inflation is steady at its target annual rate of 2%.

Most experts predict the Fed won’t start cutting rates until the summer or fall. That means we’re not likely to see average rates drop below 6% for a while. 

“Even if the Fed starts cutting rates later in the year, it will more than likely be a slow cutting process,” Thomas said.

Is now a good time to shop for a mortgage?

Even though timing is everything in the mortgage market, you can’t control what the Fed does. 

However, you can get the best rates and terms available by making sure your financial profile is healthy while comparing terms and rates from multiple lenders.

Regardless of what’s happening with the economy, the most important thing when shopping for a mortgage is to make sure you can comfortably afford your monthly payments. 

“Buying a home is the largest financial decision a person will make,” said Odeta Kushi, deputy chief economist at First American Financial Corporation. If you’ve found a home that fits your lifestyle needs and budget, purchasing a home in today’s housing market could be financially prudent, Kushi noted.

However, if you’re priced out, it’s better to wait. “Sitting on the sidelines may allow a potential buyer to continue to pay down their debt, build up their credit and save for the down payment and closing costs,” she said.