How Does the Federal Reserve Affect Mortgage Rates in the U.S.?

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Alongside economic growth, inflation, and a few other things, the Federal Reserve is just one of the many factors that can influence mortgage rates in the U.S. However, one thing that should be clarified from the start of this post, is that the Federal Reserve do not control mortgage rates. 

Who Makes or Sets the Mortgage Rates?

While many believe it is the Federal Reserve who makes the mortgage rates, they are, in fact, set in Wall Street. So, while it most certainly affects interest rates in the U.S., it does not set them. The pace of job creation, inflation, the state of the economy, and the Federal Reserve’s Monetary Policy; these are all direct influencers.

What does the Federal Reserve do?

The Federal Reserve is the central bank. An organization that guides the economy in order to stimulate growth in the employment market, while also helping to keep inflation in control. 

The relationship between the mortgage market and the Federal Reserve are intertwined. Typically, the federal funds rate will move in the same direction as the mortgage market rate. However, it’s not always easy to determine which rate follows and which leads. 

How the Federal Reserve Impacts Mortgage Rates

In a nutshell, the Federal Reserve determines what the federal funds rate will be. This is what impacts both variable and short-term interest rates. The federal funds rate is the rate in which financial institutions and banks loan money to each other overnight in order to meet the mandated reserve levels. When this rate increases, it costs the banks more to borrow money. These higher borrowing costs are passed onto the everyday consumer through higher interest rates on credit, loans, and mortgages.

In terms of timings, and this is an important topic to understand, the Federal Open Market Committee (FOMC for short) will usually give an informal indication to investors prior to any plans being made to increase or decrease interest rates. While this is not a formalized process, the individual members of the committee will indicate their intentions before the official meeting takes place. As such, this means that mortgage rates will have already started to move; either in an upwards or downward fashion, prior to the official changes or announcements of those changes being made to the public. 

What is the Federal Funds Rate at Present?

On March 15th, 2020, the Federal Reserve cut the federal funds rate by a full percentage point. This was in a direct response to the Coronavirus Pandemic and left the rate at a range of 0-0.25%

The Central Bank has stated that: 

“They plan to keep the federal funds rate near to zero, until such a point, they feel that the economy is back on track, and able to achieve specific stability and employment goals.”

The announcement that was made on March 15th followed an initial cut of half a percentage point just 12 days before. These meetings were both emergency meetings, and they are next due to meet on April 28th, 2020, to discuss any developments or plans.

When the Actions of the Federal Reserve Have Impacted Mortgage Rates

In a direct response to the Global Financial Crisis in 2008, the federal reserve embarked on a quantitative easing program. Here, the government purchased mortgage-backed securities along with government debt, aka Treasury Bonds. This program ran between November 2008– November 2014; essentially, it boosted the supply of money into the financial markets and systems across America.

The resultant impact was that it encouraged banks to loan money more easily to people and to businesses. Simply put, it got money moving again. So, one could say that, in essence, via its monetary policy, the Federal Reserve aims to influence matters within the economy, such as employment levels, borrowing, and inflation.

Additional Monetary Policy Tools

As well as targeting the federal funds rate, the Federal Reserve has a number of other tools that they use to influence and impact the monetary policy. Some of these include making alterations to the bank reserve requirements with adjustments upwards or downwards. It might also alter the terms by which it loans money to financial institutions through a discount window, along with making adjustments to the rate of interest it pays on any current bank reserves. 

In Summary 

The overriding aim of the Federal Reserve is to help sustain economic sustainability and impact the lending rates offered by banks and other financial institutions. When the Federal Reserve wants to help boost the economy, it will be cheaper to take out a mortgage or refinance a mortgage.  Alternatively, when they want to ‘clamp things down’, this will usually be a period of higher rates for borrowing, and the interest rates on mortgages will be raised.

So, while they are not in control of the mortgage rates in America, they indirectly influence and impact what those rates are, and when they need to be raised or lowered.

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