This Fed Rate Increase Might Be Good for Mortgage Rates
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Home buyers need not fret over the Federal Reserve's latest move to restrain inflation. Mortgage rates probably won't go up much, if at all, and might fall over the next few weeks.
In its latest bid to get prices under control, the Fed raised the short-term federal funds rate Wednesday by one-quarter of a percentage point to a range of 5% to 5.25%. The key phrase in the previous sentence is "short-term." Mortgage interest rates are long-term. They're as different from the federal funds rate as oaks from petunias.
Why the Fed raised the federal funds rate
The Fed balances two goals: achieving maximum employment and holding the inflation rate to around 2%. But the inflation rate has been higher than 2% for over two years.
To reduce inflation, the Fed raises short-term interest rates. The idea is that higher interest rates will force businesses and consumers to borrow less. Reduced borrowing causes consumers to spend less and companies to hire fewer workers. In turn, workers stop demanding big raises, and inflation goes down.
The Fed has raised the federal funds rate by five percentage points since March 2022, from about 0.25% to around 5.25%. The rate-raising campaign has yielded the desired effect on prices: Since June, the central bank's preferred measurement of inflation (the core personal consumption expenditures price index, or PCE) has fallen from 7% to 4.2%. The Fed intends Wednesday's increase in the federal funds rate to help push inflation even lower.
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Lower inflation should lead to lower mortgage rates
And this is where mortgage rates diverge from the federal funds rate. Mortgage rates respond to the inflation outlook. When inflation rises, mortgage rates go up, too. And when inflation looks to be headed downward, mortgage rates go down.
So, if investors believe Fed rate increases will succeed in pushing inflation lower, mortgage rates will fall. That happened after the central bank's most recent rate hike before Wednesday. The Fed raised the federal funds rate one-quarter of a percentage point on March 22. Meanwhile, the average rate on the 30-year fixed-rate mortgage dropped from 6.6% the week of March 16 to 6.43% the week of April 27, according to Freddie Mac's weekly survey.
That slight difference in rates increased home buyers' borrowing capacity by thousands of dollars. For example, take a buyer with a monthly budget of $2,000 in principal and interest. With a mortgage rate of 6.6%, that buyer could afford to borrow $313,200. But at 6.43%, the same buyer could afford to borrow $318,700 — a $5,500 increase.
Why mortgages might head downhill
If investors believe Wednesday's Fed rate increase will work its magic against inflation, then mortgage rates could head even lower in the next few weeks, just as they did in the weeks after the March 22 rate hike.
"The mortgage rate likely peaked in March and will trend downward, though modestly," Lawrence Yun, chief economist for the National Association of Realtors, said in an email.
What to watch for before the June meeting
Danielle Hale, chief economist for Realtor.com, cautioned that surprising economic data could send mortgage rates higher. She noted that this Fed meeting occurred before the scheduled releases of employment and inflation reports for April.
"Above-expected hiring, price growth or other economic activity, however, could lead to upticks in the mortgage rate in anticipation that tighter Fed policy will be needed," she said in an email.
Hale added that mortgage rates could fall gradually if those economic indicators are "lukewarm," or rates could drop rapidly if job creation or price growth are weaker than expected. The next time the Fed's monetary policy committee meets, June 13 and 14, it will have jobs and inflation data for April and May. "This means that potential home buyers, sellers and lenders will all need to remain on their toes," Hale said.
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