How the Federal Reserve Affects Mortgage Rates

The Federal Reserve is one of many influences on mortgage rates, along with inflation and economic growth.
Jun 15, 2022
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.

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. 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 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 Federal Reserve raised the target federal funds rate by 0.75 of a percentage point on June 15, 2022, to a range of 1.5% to 1.75%.

More increases are expected in 2022, according to the committee's projections. Mortgage rates sometimes rise in anticipation of Fed rate increases, and that's what happened in the first half of 2022.

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 rose to 4.75% after the June 15, 2022, Fed meeting.

On a HELOC with an interest rate of 5%, the monthly interest on a $50,000 balance would be $208.33. A Fed rate increase of 0.75% would raise the HELOC rate to 5.75% and the interest-only monthly payment to $239.58.

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