How do you know what affects your mortgage rate? Finding out when to expect the current rates to rise or fall can be a helpful skill when preparing to apply for a mortgage or refinance your current home. One guiding force of the economy is the Federal Reserve (oftentimes referred to as “the Fed”), the nation’s banking system.
Although the Federal Reserve does not directly affect the rise and fall of mortgage rates, it does decide things such as the Federal Fund Rate, which then can impact the cost of loans. Here’s what you need to know about how the Federal Reserve affects mortgage rates.
Federal Reserve Banking System
The Federal Reserve Banking System, or more simply known as the Federal Reserve, is the central bank for the United States created by Congress. The Federal Open Market Committee (FOMC) is the policymaking sector of the Federal Reserve and can make decisions based on how well the national and global economy is doing. The goal of the FOMC is to control inflation, set up national economic balance, and encourage job growth in the United States.
Federal Funds Rate
The FOMC uses the Federal Funds Rate — the rate financial institutions charge each other for short-term loans in order to meet mandated reserve levels — to dictate the nation’s interest rates at their regular meetings.
The FOMC may choose to increase or decrease the Federal Funds Rate depending on how the economy is currently doing or how they predict the economy will be doing in the near future.
For example, if the economy seems to be growing too quickly, the FOMC might raise the Federal Funds Rate to slow people down financially. However, if the economy needs growth, the FOMC may lower rates to encourage hiring, investing, taking out loans, and spending. The higher the federal rate for banks, the more expensive the interest will be for consumers and their loans, lines of credit, and mortgages.
[Related: How COVID-19 Will Impact Mortgage Rates]
Impact on Mortgage Rates
Mortgage rates are not directly dictated by the FOMC, but can be impacted by the rise and fall of the Federal Funds Rate. When the rate increases, banks have to deal with a higher cost to borrow from other banks for loans, and these higher costs can be passed down to the consumer on things such as their mortgage rate.
Recession of 2008
After the financial crisis of 2008, the FOMC kept the Federal Funds Rate relatively low (almost 0%) in order to encourage national economic growth and eventual stability. Because of the dramatic rise in unemployment to around 7% and eventually 10% in October of 2009, the FOMC took additional measures to try to balance the economy, including targeted assistance to financial institutions, quantitative easing (also known as large-scale asset purchases [LSAPs]), and forward guidance that encouraged consumers to continue to borrow.
From March 2020 to April 2020, the United States unemployment rate has jumped from a typical 4.4% to a devastating 14.7% due to the coronavirus pandemic. Similar to the FOMC’s reaction to the 2008 recession, they plan on keeping the Federal Funds Rate hovering near zero until they are confident that our nation’s economy is back on the right track. The FOMC has also begun employing emergency lending programs as well as a round of large-scale asset purchases — buying $500 billion of treasuries and $200 billion of agency-backed mortgage securities to help shelter the economy from the current crisis.
A mortgage-backed security (MBS) is a bond-like investment made up of home loans purchased from the bank that issues them. Those who invest in an MBS are essentially lending money to homebuyers who are taking out mortgages and are getting a “cut” of it through the bank as a middleman.
Current State of Mortgage Rates
Because of the current Federal Fund Rate hovering around 0% and the government’s efforts at LSAPs, mortgage rates have decreased and continue to stay relatively low.