The Federal Reserve 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. However, key players in the mortgage industry keep a close eye on the Fed, and the mortgage market’s attempts to interpret the Fed’s actions affects how much you pay for your home loan.
The Fed last month indicated it plans to hike rates three times in 2022 to battle a jump in inflation in recent months. Mortgage rates rose sharply this month as many expect the Fed to begin raising borrowing rates in March or possibly sooner. The Federal Open Market Committee holds its regular two-day meeting Jan. 25-26.
While fear of a Fed rate increase pushed up rates for now, such a move could bring some calm to mortgage markets, says Greg McBride, Bankrate’s chief financial analyst.
“Don’t project the increases in the first three weeks of 2022 over the next 49 weeks,” McBride says. “As the Fed starts to tighten, long-term rates will calm down and if inflation recedes, long-term rates might too. It’ll be an interesting year.”
The Fed also announced earlier that it will trim its monthly Treasury and mortgage-backed security purchases by $30 billion a month, up from the $15 billion pace that officials set just last month. The new pace means the U.S. central bank will no longer be buying bonds by March 2022, rather than by June 2022.
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. 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 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. 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, or 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 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.
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 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.
If the central bank wanted to reduce rates again to stimulate the economy, it would have to push rates into negative territory, a move that Powell, the Fed chairman 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 still not far from historic lows, so while you 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 wait for still lower rates. It’s clear from the Fed’s actions that the current low rates will not last.