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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 above 8%, the Fed raised interest rate four times so far. Experts expect a further rate hike in the wake of the next FOMC meeting, scheduled for Wednesday. It would send ripples through all corners of the US economy – and especially the housing market.

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.

“The Federal Reserve remains aggressive in raising interest rates to fight inflation and is now letting, perhaps more importantly, its holdings of government bonds and mortgages fall twice as fast as over the past three months,” said Greg McBride, chief financial officer of Bankrate, CNET’s sister site. “Both of these factors point to further mortgage rate hikes, at least until inflation slows significantly,” he adds.

Factors That Influence Mortgage Rates


Mortgage rates are at their highest level since 2008, exceeded 6%thanks to the policies of the Fed, the general state of the economy, persistent inflation and the strength of the labor market. If the Fed raises interest rates, it does not mean that mortgage rates will rise at the same pace, as the mortgage market may have already priced in the expected increase. “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.

Yet mortgage rates have more than doubled to around 6% since the start of the year. A fixed mortgage of $500,000 for 30 years at an interest rate of 6.5% translates into a monthly payment of approximately $2,900; with an interest rate of 3.5%, the monthly payment is $2,200.


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 is equivalent to a 28% 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.

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 and home equity lines of creditor HELOCs, is the prime rate – another base rate used by banks for loans.

With mortgage rates over 6%, a cash refinance 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 this year and exceeded the 6% mark. 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.


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