What happens to mortgage rates when the Federal Reserve lowers or raises interest rates

The Federal Reserve (aka the Fed) plays a crucial role in influencing the overall economy by adjusting what’s known as the federal funds rate. This is the interest rate banks charge each other to borrow money. While this isn’t the same as the interest rate you’d pay on a mortgage, it has a big impact on the cost of borrowing money across the economy, including mortgage rates. Here’s the basic breakdown:

• When the Fed raises rates, it’s trying to slow down inflation by making it more expensive to borrow money.
• When the Fed lowers rates, it’s aiming to stimulate economic growth by making borrowing cheaper.

However, mortgage rates don’t always move in perfect sync with the Fed’s actions. Let’s take a closer look at how it all works.

The Fed’s interest rate decisions can influence mortgage rates, but they don’t have a direct, one-to-one relationship.

Mortgage rates are shaped by several factors, including the bond market, inflation expectations, and the broader economy. Here’s a breakdown of how these elements interact:

1. Mortgage rates and the bond market: Mortgage rates are often linked to the yield on 10-year Treasury bonds. When the Fed raises its rates, bond yields usually increase, leading to higher mortgage rates. On the flip side, when the Fed lowers rates, bond yields often fall, which can pull mortgage rates down.
2. Inflation expectations: Inflation plays a big role in determining mortgage rates. When the Fed raises rates to curb inflation, mortgage rates can also increase because lenders anticipate higher inflation in the future. If inflation is under control, a Fed rate cut may lead to lower mortgage rates as the market expects stable or declining inflation.
3. Economic confidence: A Fed rate cut is often aimed at stimulating the economy, which can result in lower mortgage rates. But if there are concerns about inflation or economic instability, mortgage rates might remain elevated even after a rate cut.

Historically, Fed rate cuts have often led to mortgage rate drops, but the timing and extent of those drops depend on several factors.

Examples from the past:

• 2019: The Fed cut rates several times in response to slower economic growth. As a result, mortgage rates fell from an average of 4.54% in 2018 to 3.94% in 2019.
• 2020-2021: During the COVID-19 pandemic, the Fed slashed rates to near-zero levels. This led to record-low mortgage rates, with 30-year mortgage rates hitting a historic low of 2.65% in January 2021.

However, mortgage rates don’t always drop immediately after a Fed rate cut. In 2022, despite rate cuts, inflation concerns kept mortgage rates relatively high.

It’s easy to assume that when the Fed lowers interest rates, mortgage rates will drop, too, but it’s not always that simple.

While a Fed rate cut often leads to a mortgage rate drop, the timing and extent of the drop depend on several factors.

Factors to consider:

• Inflation: If inflation remains high, mortgage rates may not fall significantly after a Fed rate cut.
• Bond market: Mortgage rates closely follow 10-year Treasury bond yields, so watch how bond yields react after a Fed rate cut.
• Housing demand: When mortgage rates drop, demand for homes often rises, which can drive home prices up and potentially offset some of the affordability gained from lower mortgage rates.

When the Fed raises interest rates, borrowing becomes more expensive across the board, and that usually includes mortgage rates. However, the relationship between Fed rate hikes and mortgage rates isn’t always direct.

For example:

• In some cases, if a Fed rate hike signals that inflation is under control, mortgage rates may rise more slowly or even remain stable.
• But typically, when the Fed raises rates, mortgage rates follow suit, making it more costly to borrow.

A Fed rate cut often leads to increased housing demand, as lower mortgage rates make buying a home more affordable. In fact, according to Realtor, “for every 1% drop in mortgage rates, roughly 5 million more households become eligible for homeownership.”

However, when demand outpaces supply, home prices can rise, which might reduce some of the affordability gained from lower mortgage rates.

So, what should you do if you’re in the market for a home and the Fed changes rates? Here are some tips:

1. Keep an eye on mortgage trends: Don’t rely solely on the Fed’s actions. Mortgage rates are influenced by various factors, so watch the broader trend.
2. Lock in rates strategically: If you’re anticipating a rate drop, make sure to time your mortgage rate lock strategically.
3. Consult with a mortgage expert: The world of mortgage rates can be complex. Talking with a mortgage loan officer can help you navigate the changes and lock in the best rate for your situation.

At Guild Mortgage, we stay on top of the latest trends in the housing market and the economy. If you’re considering buying a home or refinancing, we can guide you through the process and explain how the Fed’s interest rate decisions might impact your mortgage options.

Ready to take the next step? Connect with an experienced mortgage loan officer today!