How The Federal Reserve Impacts Mortgage Rates: Will Mortgage Rates Fall In 2024? – Newsweek Vault (2024)

Vault’s Viewpoint

• The Federal Reserve, the nation’s central bank, sets a federal funds rate that dictates how much it costs for banks to borrow money through certain short-term loans
• The federal funds rate has an impact on mortgage rates, but it’s not a direct one
• Future rate cuts from the Fed could mean lower mortgage rates, but so could other market changes

Federal Reserve 101

The Federal Reserve functions as the central bank of the United States. When people talk about the Fed’s rates, they’re referring to the federal funds rate, which the Fed sets.

This rate doesn’t directly impact most borrowers. Instead, it’s the rate range that depository institutions (such as banks) have to charge other institutions when they lend reserve balances to each other overnight. The borrowers aren’t required to back these short-term loans with collateral, so the interest rate serves to offer some measure of security to the institution lending the money.

Even though the federal funds rate only specifically applies to financial institutions, it has a ripple-out effect on other interest rates. Because it affects how much it costs banks to lend money in the short term, it directly impacts what those financial institutions charge for short-term loans (such as credit card interest rates). And it has impacts beyond that.

Since the Fed is the nation’s core bank, other lenders look to it to determine how to set their own rates. Plus a higher federal funds rate makes it more expensive for financial institutions to operate, leading them to increase the rates they charge to make up for the added expense.

The Connection Between the Federal Reserve and Mortgage Interest Rates

When you’re trying to predict changes in mortgage interest rates, Federal Reserve rates play a role for a few reasons. Mortgage rates tend to follow federal reserve rates, particularly in the last five years.

In some cases, the Fed will get directly involved by purchasing mortgage-backed securities. This gives the central bank a way to support economic growth (one of its core goals) and, in turn, help to lower mortgage interest rates.

Beyond that, the Federal Reserve mortgage rates impact hinges on the type of mortgage you’re considering. Specifically, the connection between the Federal Reserve and mortgage interest rates depends on whether you’re choosing a home loan with a fixed rate or an adjustable one.

Fixed-Rate Mortgages

The federal funds rate most strongly affects short-term interest rates. Fixed mortgage rates, on the other hand, don’t change for the life of your loan, which is often 10 to 30 years. Because they’re a long-term loan, lenders often peg their interest rates to longer-term financing options. Specifically, mortgage rates often move with the yield on a 10-year Treasury Bond.

Generally, as Treasury yields increase, fixed interest rates on mortgages do the same. The reverse is also true.

So what’s the link between the Federal Reserve, mortgage rates and Treasury yields? As the federal funds rate goes up, the market yield on a 10-year Treasury bond tends to go down. And when bond prices drop, their interest rates generally go up.

That means when the federal funds rate rises, bond yields drop, resulting in financial institutions increasing their rates. And because many mortgage lenders tie the interest rates on fixed-rate mortgages to Treasury bonds, there is a ripple effect that causes mortgage interest rates, Federal Reserve rates and bond rates to move together.

Adjustable-Rate Mortgages

The link between the Federal Reserve and mortgage rates gets more direct when looking at adjustable-rate mortgages. While fixed-rate mortgages come with interest rates that never change while you have the loan, adjustable-rate mortgages (ARMs) allow the lending institution to adjust your rate at certain times (usually annually).

Rate changes aren’t at the lender’s sole discretion. ARMs tie your mortgage interest rate to a specific financial index. In most cases, that index is the Secured Overnight Financing Rate (SOFR). This rate relatively recently replaced the London Interbank Offered Rate (LIBOR) as the leading index to which lenders link ARMs.

The SOFR is another rate governed by the Fed, but it’s different in two key ways.

First, the Federal Reserve doesn’t set this rate. Instead, it simply measures it on an ongoing basis.

The other difference lies in the way the overnight loans attached to the SOFR get backed. Like the federal funds rate, the SOFR impacts the cost for institutions to borrow money overnight. But unlike the federal funds rate, the Secured Overnight Financing Rate is secured by Treasury securities. In other words, the Treasury securities act as collateral for these loans.

While SOFR isn’t controlled by the Federal Reserve, it is a Fed benchmark. Ultimately, with adjustable mortgage interest rates, Federal Reserve actions—the banks’ tracking and reporting of the SOFR—play a direct role.

Other Factors That Influence Mortgage Interest Rates

Looking at the big picture, the Federal Reserve’s influence on mortgage rates is clear. As the federal funds rate moves down, it becomes more affordable to get a mortgage. The reverse is also generally true. But many other factors can also impact the interest you’ll pay on a home loan.

Those include:

• The overall economy: The Federal Reserve makes decisions about its federal funds rate in response to economic conditions. Everything from the consumer price index (how much you pay for things in various categories) to the job market shapes its choice to raise rates, cut them or keep them at their current level.
• Supply and demand: Mortgage lenders function just like any other business. If they’re not getting enough work, they lower rates to try to incentivize borrowing. If too many people are applying for home loans, they raise rates because plenty of potential borrowers give them the opportunity to earn more.
• The local housing market: Mortgage rates vary depending on location. The state in which you live has a direct impact on how much lenders will charge you in mortgage interest.
• The loan type: Because adjustable-rate mortgages give lenders the opportunity to earn more in interest if financial indexes rise, lenders see them as lower risk. As a result, ARMs usually start with a lower interest rate than fixed-rate mortgages. On top of that, you can usually get a lower interest rate if you choose a loan that has government backing. This includes mortgages backed by the Federal Housing Administration (FHA loans), United States Department of Agriculture (USDA loans) or the Department of Veterans Affairs (VA loans).
• The loan term: The shorter your mortgage, the less lenders generally charge in interest.
• Your borrower profile: Buying a home with bad credit can be difficult and more expensive. The riskier you look to a lender, the more they raise the interest on your loan. To determine your risk level, financial institutions evaluate your credit score, income, other debt, how much money you can put up for your down payment, and other factors.

While you can’t affect the Federal Reserve, mortgage rates are determined by some factors within your control. Working on your credit score and exploring different mortgage types and terms can help you find the lowest rate possible.

The Current Rate Environment: Federal Reserve, Mortgage Rates and What To Expect

The Federal Reserve has held the federal funds rate steady since August 2023. During that time, the average interest rate on a 30-year fixed-rate mortgage climbed to a high of 7.79% but has since settled back down to 6.88%, very close to its August 2023 rate of 6.90%. That’s according to data from the Federal Reserve Bank of St. Louis.

Earlier this year, experts predicted that the Fed would start cutting rates soon—and that mortgage rates would follow. But those predictions were made assuming inflation would continue to cool. Recent consumer price index data actually shows inflation ticking up again.

As a result, the Fed has indicated that they don’t want to cut rates too quickly. Ultimately, if you’re waiting for rate cuts to potentially bring mortgage rates down, you may need to wait until later in the year.

The Federal Open Market Committee (FOMC), the board that makes decisions at the Fed, meets eight times a year. Its upcoming 2024 meetings fall on the following dates:

• March 19 to 20
• April 30 to May 1
• June 11 to 12
• July 30 to 31
• September 17 to 18
• November 6 to 7
• December 17 to 18

Right now, most experts don’t predict federal funds rate cuts until the summer meetings or later.