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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.
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.
After its regular meeting ending Jan. 26, 2022, the FOMC implied that it would raise the federal funds rate at its next scheduled meeting, March 15 and 16.
Three or four quarter-point increases are expected in 2022, according to the committee's projections. Mortgage rates are likely to rise, too, although there's merely an indirect link between mortgage rates and the federal funds rate.
The Fed has another way of raising long-term interest rates, involving its purchases of Treasurys and mortgage-backed securities.
The Fed confirmed at its January meeting that it would halt the purchases in March. It issued a set of principles for reducing its holdings of those instruments. Those actions were deemed likely to push mortgage rates higher.
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. The prime rate has been 3.25% since March 2020.
On a HELOC with an interest rate of 4.5%, the interest-only monthly payment on a $50,000 balance would be $187.50. A Fed rate hike of one-quarter of a percentage point would raise the HELOC rate to 4.75% and the interest-only monthly payment to $197.92.