Although the Fed does not directly set mortgage rates, it does exert influence. Mortgage rates are determined by economic factors such as inflation, the strength of the job market, economic trends and the Federal Reserve’s monetary policy, which is set by the Federal Open Market Committee.
The Fed has been busy keeping inflation under control in 2022, but it’s an uphill battle. The Fed has raised interest rates four times so far as inflation is above 8%. Experts expect another rate hike at the next Federal Open Market Committee meeting scheduled for Wednesday. This will make waves in every corner of the U.S. economy—especially the housing market.
Read on to learn more about the relationship between the Federal Reserve, mortgage rates, and the housing market.
What role does the Fed play?
Founded in 1913, the Federal Reserve consists of 12 regional Federal Reserve Banks and 24 branches and is governed by a Board of Governors, all of which are voting members of the Fed’s policymaking body, the FOMC.
The FOMC is responsible for setting overall monetary policy to stabilize the economy and its growth. It does this in part by setting the federal funds rate, the benchmark rate at which banks borrow and lend money. When the Fed raises rates, banks typically pass the hike on to consumers, pushing up overall U.S. borrowing costs. This affects potential home buyers.
Chief Financial Officer Greg McBride said: “The Fed remains aggressive in raising interest rates to fight inflation and, perhaps more importantly, is now reducing its holdings of Treasuries and mortgages at twice the rate of the past three months. Loan-backed bonds.” CNET’s sister site Bankrate. “Both of these factors point to further increases in mortgage rates, at least until inflation slows significantly,” he added.
Factors Affecting Mortgage Rates
Macro factors
Mortgage rates are at their highest level since 2008, above 6%, due to Federal Reserve policy, general economic conditions, ongoing inflation and a strong job market. If the Fed raises rates, it doesn’t mean that mortgage rates will rise in tandem — because the mortgage market may have already priced in the expected rise. “Mortgage rates won’t change as a result of this rate hike, but they will respond to expected changes in inflation, interest rates and the health of the economy,” McBride said.
Still, mortgage rates have more than doubled since the start of the year to around 6%. A $500,000 30-year fixed-rate mortgage at 6.5% equals about $2,900 in monthly payments; 3.5% and $2,200 in monthly payments.
Micro factors
But there are other factors that can affect mortgage rates. When loan volume slows, lenders lower interest rates and ease borrowing requirements. Borrowers with below-average credit ratings may actually be more likely to get a mortgage in a high-interest-rate environment.
When it comes to how banks make lending decisions, macroeconomic factors are only part of the equation. There are a few more specific factors that determine your specific mortgage rate. These include:
- Your credit score
- The home’s location
- The home’s price
- Your down payment
- The loan amount
- The loan type and term
- The type of interest rate.
How the Fed’s Decision Affects Mortgage Rates
Although the Fed does not directly set mortgage rates, its decisions on the federal funds rate ultimately affect mortgage rates and the broader housing market. “Typically, when the Fed raises the federal funds rate, it causes other interest rates in the economy, such as mortgage rates, to rise with it,” said Taylor Marr, deputy chief economist at real estate brokerage Redfin.
When the Fed raises borrowing costs, fewer people borrow. This has dampened demand for goods and services, including homes. So there is a silver lining for some potential homebuyers.
Things to Consider When Buying a Mortgage
But higher mortgage rates will stress many borrowers. “The rise in mortgage rates since the start of the year has translated into a 28 per cent increase in home prices — on top of the already phenomenal appreciation over the past few years,” McBride said.
While it’s tempting to wait for higher mortgage rates while talking about a possible recession, it’s risky to time the market and wait for mortgage rates or home prices to fall. Even if home prices fall as expected and mortgage rates rise, you may still end up with higher monthly mortgage payments even if you get a good deal on your home.
“Higher rates just mean buyers are getting less affordable,” Marr said.
No matter what happens to the economy, the most important thing to consider when buying a mortgage is to make sure you can afford your monthly payments. When making important financial decisions, like buying your first home, the most important thing is to keep your financial life healthy. Make sure you always shop around and compare mortgage lenders to make sure you’re getting the best rates and terms.
How rising interest rates affect your assets
If you already own a home, you won’t be as affected by fluctuations in mortgage rates as a borrower applying for a new mortgage. But they can affect your home equity. Of greater concern to homeowners seeking home equity and home equity lines of credit (HELOCs) is the prime rate — another benchmark rate banks use to lend.
With mortgage rates above 6%, for most homeowners who have already gotten lower mortgage rates during the pandemic, paying for a refinance doesn’t make financial sense. In an environment of rising interest rates, home equity loans and HELOCs can be a good financing option. You can borrow against your home at a relatively low rate, and a home loan gives you a fixed rate so you don’t have to worry about the next rate hike from the Fed.
As a homeowner, keep in mind that while mortgage rates may not directly affect you, higher rates may limit the number of potential home buyers in your local market if you’re trying to sell your home, McBride warns.
Final result
When the Fed raised its benchmark rate, it indirectly pushed up mortgage rates. Mortgage rates have more than doubled since the beginning of the year to more than 6%. Higher mortgage rates make buying a home more expensive. So when you’re looking for a mortgage, be sure to compare the rates and terms that banks and lenders offer you. The more lenders you interview, the better your chances of getting a lower mortgage rate, especially in today’s environment of rising interest rates.
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