How the Fed Affects Mortgage Rates

It’s a common assumption that when the Federal Reserve (or Fed) lowers interest rates, that mortgage rates will fall as well. The truth is that the Federal Reserve doesn't directly control the interest rates that homeowners pay on their mortgages. But the Federal Reserve does have a great deal of indirect influence over the level of mortgage rates and whether mortgage rates are headed up or down. The Fed's influence on mortgage interest rates comes through the Federal Funds Rate and discount rate and other actions the Federal Reserve may take.

Federal Reserve sets target rates

The Federal Reserve periodically sets a target for the "Federal Funds Rate," which is the interest rate that depository institutions (i.e. banks) charge one another for overnight loans of their excess reserve funds. This rate is also called the “Fed Funds Fate” or the “funds rate.”

The Federal Reserve also sets the "discount rate," which is the interest rate the Fed charges commercial banks when they borrow money from the Fed.

When people say the Federal Reserve raised or lowered interest rates they are usually talking about the federal funds rate or discount rate, which are both rates the Fed can control. They are not talking about mortgage rates because the Federal Reserve can't directly control those rates.

The Federal

Funds Rate and discount rate can signal the level and direction of mortgage rates because short-term rates typically fluctuate as the Federal Reserve raises or lowers its targets and that can have an indirect effect on mortgage rates. Indeed, there is a strong correlation between the discount rate and mortgage rates. If you looked at the discount rate and the average rate on a 30-year fixed-rate mortgage on a chart, you'd be able to see the pattern. The trend lines for the discount rate and the interest rate you'll pay on a mortgage aren't identical, but they are very much in sync.

Federal Reserve affects mortgage rates

The Federal Reserve also affects mortgage rates in other ways. For instance, the Fed can buy debt instruments, short-term Treasuries and securities that are backed by mortgages to lower interest rates, create demand for loans and encourage lending and borrowing. These actions help to lower mortgage interest rates even though the Fed doesn't control those rates directly.

Low rates make mortgages more affordable, so more people can purchase a home, refinance a mortgage or borrow against their home equity. That's why the Fed's actions are so important to people who want to apply for a mortgage and are concerned about the interest rate they'll pay.

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Source: www.lendingtree.com

Category: Credit

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