How Do Federal Interest Rates Affect Mortgage Rates

Federal Interest Rates –The Federal Reserve System, also known as the Fed, impacts millions of economic decisions each day, including every decision a homeowner makes related to buying a home. This includes the Federal interest rate, which are set by the Fed, and subsequently how they affect mortgage rates. When we talk about Federal interest rate, we’re typically referring to the Federal Funds Rate. It’s called the Federal Funds Rate because it involves banks and banks need funds. The Federal Funds Rate is the rate at which these banks lend funds to one another, overnight, and is determined by the Fed when needed.

The Relationship Between Federal Interest Rates and Mortgage Rates

The Federal Funds Rate doesn’t have a direct impact on mortgage rates. However, when the Fed decides to raise or lower the Federal Funds Rate, it usually influences the decisions of other banks, such as those that lend money in the form of Mortgages. Mortgage lenders typically adjust their own interest rates to reflect changes in the Federal Funds Rate. That said, most mortgages are re-priced periodically, depending on the type of mortgage, so very short-term changes in the Federal Funds Rate won’t necessarily have an immediate effect on mortgage rates.

How an Increase in Federal Interest Rates Impacts Mortgage Rates

When interest rates increase, mortgage lenders typically increase their own interest rates accordingly. Homeowners should expect that a 0.25% increase in the Federal Funds Rate will mean a 0.25% increase in mortgage rates. It’s important to note that this increase in mortgage rates won’t necessarily happen overnight. In some cases, it might take the lender time to adjust the rates, or the homeowner might not have their next mortgage rate-reset period for a few months.

How a Decrease in Federal Interest Rates Impacts Mortgage Rates

When the Federal Funds Rate decreases, mortgage lenders typically follow suit and decrease their own interest rates. Again, homeowners should expect that a 0.25% drop in the Federal Funds Rate will mean a 0.25% drop in mortgage rates. Just like with an increase, a decrease in mortgage rates wouldn’t necessarily happen overnight. In some cases, it could take the lender time to adjust the rates, or the homeowner might not have their next mortgage rate-reset period for a few months.

The Benefits of Understanding Federal Interest Rate Changes for Homeowners

Knowledge of how Federal interest rate fluctuations can and do impact mortgage rates is a powerful tool for homeowners. By understanding this connection, homeowners can make informed decisions about when to refinance their mortgages and when to lock in a new mortgage rate. For example, a homeowner aware of the Federal interest rate environment might decide to lock in a fixed-rate mortgage rather than an adjustable-rate one, if they were expecting Federal interest rate to increase.

Conclusion

Federal interest rates and mortgage rates are inextricably linked. Knowing how these two rates, and the changes to them, affect each other will enable homeowners to make better decisions regarding the timing of their mortgage rate resets, and even the type of mortgage they choose. Homeowners will also be better equipped to take advantage of beneficial interest rate fluctuation environments and prepare for potentially harsh ones.