How Does the Fed Affect Mortgage Rates?
Homebuyers are continuing to enjoy super-low mortgage rates, thanks largely to the fact that the Fed has decided to keep a lid on interest rates – for the time being, anyway.
The Fed – as the Federal Reserve is affectionately referred to – is a government agency that’s commissioned by Congress to serve as the central bank of the US. It influences the US economy through financial actions, one of the most important being the federal funds rate that significantly affects mortgage rates.
While the Fed can’t directly set mortgage rates, the actions it takes certainly influences them indirectly, albeit significantly.
Economists and investors all across the country have been sitting on the edge of their seats in anticipation of an interest rate hike. But the last time the Fed met up, the decision was to keep rates low, especially in the wake of the economic debacle in China and other nations overseas – but that makes for a different discussion altogether.
Let’s talk about how the Fed affects mortgage rates, and why you should care.
Building Back the Economy After the Financial Crisis in 2008
We all remember the economic nightmare that started in late 2007/early 2008. That’s when all hell broke loose, with everyone fearing we’d see another Great Depression that hadn’t been experienced since the crash of 1929.
In response to this crisis, the Federal Reserve took action to help bring the economy back up. It did this by easing up on interest rates and buying mortgage-backed securities and government debt. The program, which has since ended as of 2014, boosted the cash supply in the country’s financial systems.
This nudged banks and other lenders to loan out money more easily. It also spiked the price and decreased the supply of the types of securities that the Fed snatched up.
This all affects lending rates – including mortgage rates – by keeping them low.
When the Fed takes steps to maintain economic stability, its actions have a big impact on lending rates. You can expect mortgage rates to be a lot more affordable when the Fed take steps to strengthen the economy. The flip side is also true – when the Fed decides to put a squeeze on the economy, it takes money out of the system, which tends to increase rates, including those for mortgages.
When the Fed cuts rates, it typically cuts the Fed Funds Rate, which is the short-term interest rate that financial institutions lend money to each other to meet mandated reserve levels. When the Fed lowers this rate, the Prime Rate (the rate that banks give their best clients) typically drops in response.
Fantastic. But what does this really mean to you?
Basically, it means that anything that’s directly affected by Prime Rate will also be directly affected by any rate cut by the Fed – usually, short-term loans.
Mortgage rates aren’t directly affected because they’re typically long-term rates that are influenced by buyers and sellers in the bond market. Any movement in this market will cause a fluctuation in mortgage rates. When this happens, don’t be surprised to get one quote from a lender on Monday, then a completely different quote on Thursday.
At the end of the day, a healthy economy is good for the real estate market. A liquid real estate market helps the mortgage market, and keeps the rates competitive.
Other Factors Influencing Mortgage Rates
Even though the Fed has a big influence on mortgage rates, it’s not the only one. There are other factor that influence these rates, including the following:
▪ Growth – The economy moves up and down, and is highly sensitive to things like low unemployment rates. When the economy is experiencing a growth spurt, demand for money increases, which drives interest rates up. The opposite is also true: when economic growth slows down, interest rates tend to decrease.
▪ Inflation – This increases prices and puts a wrench in spending power in the US economy, which slows growth. This affects future homeowners by pushing mortgage rates higher as lenders boost interest rates to protect profits against the effects of inflation.
▪ New Home Sales – The construction and sale of new homes has a big impact on the demand for mortgage borrowing. When there is strong growth in new home sales, there tends to be a higher demand for mortgage borrowing. And higher demand for mortgage lending fuels pressure to boost mortgage interest rates. On the other hand, a drop in new home sales means downward pressure on mortgage rates as a result of diminished mortgage borrowing.
Regardless of the influence that the Fed has on mortgage rates, it’s important to work with a mortgage specialist who has a finger on the pulse of the mortgage market. As it stands, mortgage rates are incredibly low, but economists are anticipating a hike in rates any time, considering this extended period of low interest.
If you’ve got all your financial ducks in a row and have teamed up with a solid mortgage broker and real estate agent, now may be as good a time as ever to buy a home and lock into a mortgage.
