How the Federal Reserve Affects Mortgage Rates

Although the Federal Reserve does not set mortgage rates directly, it does play an influential role. Mortgage rates are determined by economic factors such as inflation, the strength of the labor market, the trajectory of the economy, and the Fed’s monetary policy, which is set by the Federal Open Market Committee.

The Federal Reserve has been busy in 2022 trying to control inflation, but it’s been an uphill battle. With inflation just above 7%, the Fed has now raised interest rate seven times, raising its benchmark interest rate by 50 basis points at its last meeting of the year on Wednesday. This increase places the benchmark rate at its highest level in 15 years. The December meeting signaled that more rate hikes are coming in 2023 and indicated rates could top 5%, although Fed Chairman Jerome Powell suggested he was open to a hike rates of just 25 basis points at the next Fed meeting in February.

“Mortgage rates will not move in response to this rate hike, but will respond to changing expectations for inflation, interest rates and the health of the economy,” McBride said.

Read on to learn more about the relationship between the Fed, mortgage rates, and the housing market.

What is the role of the Federal Reserve?

Established in 1913, the Federal Reserve consists of 12 regional Federal Reserve banks and 24 branches and is governed by a Board of Governors, all of whom are voting members of the FOMC, the Fed’s monetary policy governing body. .

The FOMC is responsible for setting global monetary policy, with the aim of stabilizing the economy and its growth. It does this, in part, by setting the federal funds rate – the benchmark interest rate at which banks borrow and lend their money. When the Federal Reserve raises this rate, banks typically pass the rate hike on to consumers, driving up the overall cost of borrowing in the United States. This has an impact on potential buyers.

“Mortgage rates are down about half a percentage point since peaking at over 7% in October,” McBride said. “But with mortgage rates still doubling from what they were at the start of the year, that doesn’t do much for the affordability issues potential buyers face.”

Factors That Influence Mortgage Rates

Macro-factors

Mortgage rates are at their highest level in two decades, exceeded 7% earlier this year, thanks to Fed policies, the overall state of the economy, persistent inflation and the strength of the labor market. While the Fed will likely raise the benchmark interest rate by half a percentage point on Wednesday, that doesn’t mean mortgage rates will rise in parallel, as the mortgage market may have already priced in the increase. planned.

Yet mortgage rates have more than doubled since the start of the year. A fixed mortgage of $500,000 for 30 years at an interest rate of 7% translates into a monthly payment of approximately $3,000; at an interest rate of 3.5%, the monthly payment is $2,200.

Microfactors

But there are other factors that affect mortgage rates. When lending volume slows, lenders cut rates and ease their credit requirements. Borrowers with a below average credit score may actually have a better chance of qualifying for a mortgage in a higher rate environment.

When it comes to determining how a bank decides to grant a loan, macroeconomic factors are only part of the equation. There are a handful of much more specific factors that determine your particular mortgage interest rate. These include:

How Fed Decisions Affect Mortgage Rates

Although the Fed does not set mortgage rates directly, its decisions regarding the federal funds rate ultimately have an impact on mortgage rates and the housing market in general. “Typically, when the Fed raises the fed funds rate, it also causes other rates in the economy to rise, such as mortgage rates,” says Taylor Marr, deputy chief economist at Redfin, a real estate brokerage firm.

When the Fed makes borrowing more expensive, fewer people borrow. This reduces the demand for goods and services, including houses. And that’s why there’s a potential silver lining in a rate hike for some potential buyers.

Things to consider if shopping for a mortgage

But rising mortgage rates will have an impact on many borrowers. “The year-to-date increase in mortgage rates equates to a more than 32% increase in house prices — and that’s on top of the already sky-high appreciation of the past two years,” McBride said.

While it’s tempting to wait for higher mortgage rates when talking about a potential recession on the horizonit’s risky try to time the market and wait for mortgage rates or house prices to drop. Even if house prices depreciate and mortgage rates rise, as expected, you could still end up with a higher monthly mortgage payment despite a good deal on your home.

“Higher rates just mean homes will become more unaffordable to buyers,” Marr says.

“I don’t expect we’re going to see a big drop in house prices, generally speaking,” McBride said. “There may be markets or zip codes more likely to pull back, but overall we expect more of a price leveling than a broad-based decline.”

Regardless of what’s going on with the economy, the most important thing to consider when shopping for a mortgage is making sure you can comfortably afford your monthly payments. Maintaining a healthy financial life on a daily basis is what matters most when making an important financial decision like buy your first house. Be sure to always shop around and compare mortgage lenders to ensure you get the best rates and terms available to you.

The impact of rising interest rates on your home equity

If you already own a home, fluctuating mortgage rates will not impact you as much as borrowers apply for a new mortgage. But they can have an impact the equity in your home. What’s more important for homeowners buying home equity loans and home equity lines of creditor HELOCs, is the prime rate – another base rate used by banks for loans.

With mortgage rates approaching 7%, cash refinancing won’t make financial sense for most homeowners who have already locked in lower mortgage rates during the pandemic. In a rising interest rate environment, home equity loans and HELOC can be a good financing option. You can borrow against the equity in your home at a relatively low interest rate and with a home equity loanyou can lock in a fixed interest rate so you don’t have to worry about the next Fed rate hike.

As a homeowner, keep in mind that while mortgage rates don’t directly impact you, if you’re trying to sell your home, higher rates could limit the number of potential buyers in your local market, warns McBride.

The bottom line

When the Federal Reserve raises the benchmark interest rate, it raises mortgage rates. Mortgage rates have more than doubled since the start of 2022 and topped the 7% mark earlier this year. Higher mortgage rates make buying a home more expensive. So if you’re shopping around for a mortgage, be sure to compare the rates and terms offered to you by banks and lenders. The more lenders you ask, the better your chances of getting a lower mortgage rate, especially in today’s rising interest rate environment.