How the Federal Reserve Affects Mortgage Rates

The Federal Reserve is one of many influences on mortgage rates, along with inflation, economic growth and other elements.

Holden LewisOctober 21, 2019
How the Federal Reserve Affects Mortgage Rates
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The Federal Reserve doesn't set mortgage rates, but it does affect mortgage rates indirectly.

Mortgage rates are determined 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.

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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. Most meetings result in no change to the federal funds rate. At the conclusion of each meeting, the committee releases a statement explaining its reasoning. Three weeks later, the meeting's minutes are released, serving Fed nerds even more details.

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 hard to say whether mortgage rates follow the Fed's actions or the other way around.

The federal funds rate influences interest rates for longer-term loans, including mortgages.

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. Occasionally, the Fed and mortgage rates move in opposite directions.

What is the current federal funds rate?

The target federal funds rate has been a range of 0% to 0.25% since an emergency rate cut on March 15, 2020. The emergency was the COVID-19 pandemic and the disruption in economic activity that resulted.

“The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook,” the rate-setting committee explained.

The Fed began to buy hundreds of billions of dollars' worth of Treasurys and mortgage-backed securities to keep cash in the financial system and to keep long-term interest rates down.

In its regular meeting ending Jan. 27, 2021, the FOMC said the economy's path "will depend significantly on the course of the virus, including progress on vaccinations." It reiterated that the Fed's goal is to achieve an inflation rate at 2% over the long run. Because the inflation rate has remained under 2% for a few years, the rate-setting committee aims to let it rise above 2% for a while to balance things out. That means keeping short-term rates low "until these outcomes are achieved." It might take a while.

Federal funds rate and HELOCs

Although the Fed doesn’t determine mortgage rates, it 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.

When the FOMC cuts the federal funds rate, interest rates on HELOCs go down, too. The March 15, 2020, reduction of one percentage point saved $100 a year — or $8.33 a month — on the interest-only payment of a HELOC with a $10,000 balance. It reduced the prime rate to 3.25% from 4.25%.

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