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How the Federal Reserve Affects Mortgage Rates

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The Federal Reserve doesn’t directly set mortgage rates, but it can influence them.

For example, the Fed can buy or sell mortgage-backed securities — bond-like securities that are sold to investors — that pressure lenders to offer different rates. However, they can’t call a lender and say, “You must now offer mortgages with interest rates of 3%.”

Because the Fed doesn’t directly set mortgage rates, rates may not rise or fall by the same amount that the Fed targets when it announces hikes or cuts to the federal funds rate (more on this later). So even though the Federal Open Market Committee (FOMC) is poised to announce a 50 basis point hike to the target fed funds rate at their next meeting on June 14-15, mortgage rates might not increase by that much. Instead, they could increase by the same amount, stay the same or even fall slightly.

What Fed rate changes mean for mortgages

Fed rate changes can have a noteworthy impact on mortgages — not only in terms of their rates, but also in how appealing (or even accessible) they are to borrowers.

For example, because the Fed’s policy decisions this year have contributed to rising mortgage rates, it’s become more difficult for many new borrowers to afford a home loan. This challenge is one of the reasons why the number of purchase mortgage applications is falling.

Similarly, rising rates have also made refinancing a mortgage much less attractive, as today’s rates are higher than what many current homeowners are already paying on their loans.

How mortgage rates are determined

Mortgage rates are set by lenders based on various factors — these include, but are not limited to:

  • How likely they think a given borrower is to pay back their loan
  • How many loans they want to originate
  • How much profit they want to make on each loan

They can also be influenced by macroeconomic factors, like inflation or whether the Federal Reserve is buying mortgage-backed securities.

Typically, the less risky a loan appears to a particular lender, the lower the rate it’ll offer. On the other hand, the more likely a lender thinks that a borrower won’t pay them back, the higher the interest rate it’ll charge. They do this because they’re trying to make enough money to offset the risk of the borrower defaulting on their loan. For the most part, lenders will view borrowers who earn higher incomes or have higher credit scores as less risky; in turn, they’ll offer those borrowers lower rates.

Different lenders have different policies regarding how they calculate risk or the kind of clientele they prefer to work with. For this reason, different lenders may offer different rates to the same person — and why shopping around for a mortgage can result in such significant savings.

Frequently asked questions

What is the Federal Reserve?

The Federal Reserve is the United States’ central bank. It exists to help keep the economy stable via monetary policy.

What is the current federal funds rate?

The federal funds rate is the target rate at which banks should lend to each other.

The current target federal funds rate is between 0.75% and 1%, but will likely rise to between 1.25% and 1.50% after this month’s FOMC meeting.

The current effective federal funds rate — the median rate on overnight federal funds transactions reported to the Fed — is 0.83%.

Does the federal funds rate impact home equity lines of credit?

Unlike most mortgages, home equity lines of credit (HELOCs) have variable rates that are usually directly tied to the fed funds rate. As a result, if the Fed decides to raise its target fed funds rate, you can generally expect HELOC rates to go up by about the same amount.

Keep in mind, however, that while HELOC rates are usually variable, fixed-rate HELOCS do exist. Not only that, but some HELOCs may have fixed-rate introductory periods where your rate won’t go up even if the fed funds rate does. If you’re curious about how Fed policy changes are likely to impact your HELOC, your best option is to contact your lender and ask what you should expect.


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