How the Federal Reserve Affects Mortgage Rates

The Federal Reserve is one of many influences on mortgage rates, along with inflation and economic growth.
Holden Lewis
By Holden Lewis 
Updated
Edited by Mary Makarushka
How the Federal Reserve Affects Mortgage Rates

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The Federal Reserve influences mortgage rates, but doesn't set them. At its Jan. 31, 2024, meeting, the central bank kept the federal funds rate unchanged, and said it will keep an eye on economic developments to decide what its next rate move will be.

Mortgage rates are influenced by many elements, including the inflation rate, the pace of job creation, and whether the economy is growing or shrinking. The Federal Reserve's monetary policy is a factor, too, and is set by the Federal Open Market Committee.

What the Federal Reserve does

The Federal Reserve is the nation's central bank. It guides the economy with the twin goals of encouraging job growth while keeping inflation under control.

The FOMC pursues those goals through monetary policy: managing the supply of money and the cost of credit. Its main monetary policy tool is the federal funds rate, which is the interest rate that banks charge one another for short-term loans. Although there's no such thing as "federal mortgage rates," the federal funds rate influences interest rates for longer-term loans, including mortgages.

The FOMC meets eight times a year, roughly every six weeks, to tweak monetary policy. The Federal Reserve has maintained the federal funds rate in a range of 5.25% to 5.5% since July 2023. Its next meeting is March 19-20, 2024.

Central bankers have signaled that the Fed might pivot to cutting the federal funds rate this year, probably multiple times. Investors in interest rate markets expect the first in a series of rate cuts to happen in the March meeting or the one after that, April 30-May 1.

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The Federal Reserve, mortgage rates and inflation

Mortgage rates respond to many economic signals besides the federal funds rate. One major influence is inflation. The Fed's goal is to maintain an inflation rate of around 2%. Inflation has been well above that for some time.

The consumer price index rose from November to December, the Bureau of Labor Statistics announced Jan. 11. It went from 3.1% to 3.4%. The core CPI, which excludes food and energy prices, fell from 4% to 3.9%.

Although these numbers are higher than the Fed wants, the inflation rate has been falling and seemingly is on the way to the Fed's 2% target. As a result, the Fed is expected to cut the federal funds rate this spring.

The availability of jobs also influences monetary policy. When the economy is creating lots of jobs, it means the economy is growing — a situation that tends to push the inflation rate higher. The Fed responds by raising interest rates. When job creation slows down, or when many people lose their jobs, inflation tends to fall. The Fed responds by cutting interest rates.

In the past few months, the economy has been in an in-between place, in which the inflation rate is high, but falling, while job creation and consumer spending remain fairly strong. The overall state of the economy creates ambiguity surrounding what the Fed should and will do next.

Do mortgage rates follow Fed rates?

The Fed and the mortgage market move like dance partners: Sometimes the Fed leads, sometimes the mortgage market leads, and sometimes they dance on their own.

The federal funds rate and mortgage rates usually move in the same direction. But it's sometimes hard to say whether mortgage rates follow the Fed's actions or the other way around.

The FOMC prefers to give investors a heads-up whenever it plans to raise or cut short-term interest rates. Members of the committee advertise their intentions by sprinkling hints into their public speeches. By the time the committee meets, there's usually a consensus among investors as to whether the Fed will cut rates, raise them or keep them unchanged.

As that consensus solidifies before an FOMC meeting, mortgage rates usually drift in the direction that the Fed is expected to move. Often, by the time of the meeting, mortgage rates already reflect the expected rate change.

At the same time, mortgage rates move up and down daily in reaction to the ebb and flow of the U.S. and global economies, which are the same developments that the Fed responds to.

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Federal funds rate and HELOCs

Although there's merely an indirect link between mortgage rates and the federal funds rate, the Fed does have a direct influence on the rates charged on home equity lines of credit, which typically have adjustable rates.

Interest rates on HELOCs are linked to the Wall Street Journal prime rate, which is the base rate on corporate loans by the largest banks. The prime rate, in turn, moves with the federal funds rate. The prime rate is 8.5%.

Current prime rate

Prime rate last month

Prime rate in the past year — low

Prime rate in the past year — high

8.50%.

8.50%.

7.75%.

8.50%.

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