How the Federal Reserve Affects Your Mortgage Rate
A SmartKey Lending Insight
Mortgage rates are one of the most influential factors in homeownership costs, and while many borrowers pay close attention to the rise and fall of these rates, fewer understand the forces that drive them. One of the most powerful of these forces is the Federal Reserve—or simply, the Fed. Whether you’re a first-time homebuyer or a seasoned real estate investor, knowing how the Federal Reserve influences mortgage rates can empower you to make smarter financing decisions.
In this guide from SmartKey Lending, we’ll explore the relationship between the Fed and mortgage rates, why it matters, and how you can use this knowledge to time your loan wisely.
What Is the Federal Reserve?
The Federal Reserve is the central bank of the United States. It’s responsible for maintaining economic stability through various tools, primarily by influencing interest rates and controlling the money supply. It does not set mortgage rates directly but has a profound indirect impact on them.
The Fed’s responsibilities include:
Setting the federal funds rate (the interest rate banks charge each other for overnight loans)
Controlling inflation and employment levels
Regulating banks and financial institutions
Acting as a lender of last resort
Its decisions send signals to the broader financial markets, including those that determine mortgage rates.
How the Federal Funds Rate Affects Mortgage Rates
The federal funds rate is the benchmark for short-term interest rates in the U.S. economy. When the Fed raises or lowers this rate, it impacts everything from credit card interest to savings account yields—and yes, mortgage rates.
Here’s how it works:
1. Cost of Borrowing Increases or Decreases
When the Fed raises the federal funds rate, banks and lenders face higher costs to borrow money. To maintain profitability, they typically pass on those higher costs to consumers by increasing interest rates on loans—including mortgages.
When the Fed lowers the rate, borrowing becomes cheaper, and mortgage rates tend to follow.
2. Investor Reactions in Bond Markets
Mortgage rates are closely tied to the 10-year U.S. Treasury yield, which is driven by investor behavior. When the Fed signals future rate hikes, bond yields often rise in anticipation. Mortgage-backed securities (MBS)—which are bundles of mortgages sold to investors—adjust accordingly. Higher yields mean higher returns for investors, and thus higher mortgage interest rates for consumers.
Fixed vs. Adjustable Rates: Who Feels the Fed More?
Whether you choose a fixed-rate mortgage or an adjustable-rate mortgage (ARM) will influence how directly the Fed’s decisions impact your mortgage payments.
Fixed-Rate Mortgages
The interest rate is locked in for the life of the loan (15, 20, or 30 years).
Fed rate hikes don’t directly affect your payments once the loan closes.
However, if you’re applying for a fixed-rate loan, your rate will be influenced by market expectations shaped by the Fed.
Adjustable-Rate Mortgages (ARMs)
These loans have variable interest rates that adjust after a set period (e.g., 5/1 ARM: fixed for 5 years, then adjusts annually).
ARMs are directly influenced by short-term interest rates, which move in step with the federal funds rate.
If the Fed raises rates, your future mortgage payments may increase significantly.
Why the Fed Changes Rates
Understanding why the Fed raises or lowers interest rates can help borrowers anticipate future changes in mortgage rates. The Fed’s goals are:
1. Controlling Inflation
When inflation rises above the Fed’s target (usually around 2%), the Fed may raise rates to cool down the economy and reduce spending. Higher mortgage rates are a natural outcome of this process, often slowing down home buying.
2. Stimulating Economic Growth
In times of economic downturn (e.g., during a recession or global crisis like COVID-19), the Fed lowers interest rates to encourage borrowing and investment. This typically leads to lower mortgage rates, making it a favorable time to buy or refinance a home.
Real-World Example: Fed Rate Decisions and Mortgage Rates
Let’s look at recent trends to see how Fed decisions played out:
2020: In response to the pandemic, the Fed slashed the federal funds rate to near 0%. Mortgage rates dropped to historic lows, with 30-year fixed rates hovering around 2.7%.
2022–2023: The Fed raised rates aggressively to combat inflation. Mortgage rates surged, hitting 7% in some markets—nearly triple the rates from 2020.
This shows how closely tied mortgage affordability is to the Fed’s monetary policy.
What This Means for You as a Borrower
Whether you’re purchasing your first home or investing in a fix-and-flip project, the Fed’s decisions can influence your financing strategy. Here’s how to respond:
1. Lock in Rates When They’re Low
If you’re shopping for a mortgage and rates are falling, consider locking in a low fixed rate to protect yourself from future increases.
2. Choose the Right Loan Type
Opt for a fixed-rate mortgage if you want stability in a rising-rate environment.
Consider an ARM if rates are expected to decline or if you plan to sell or refinance before the rate adjusts.
3. Time Your Refinancing
Lower Fed rates can be an ideal time to refinance your existing mortgage. Even a 1% drop in your interest rate could save thousands over the life of the loan.
SmartKey Lending’s Expert Tip:
At SmartKey Lending, we monitor Federal Reserve trends and economic indicators closely to help our clients secure loans at the best possible terms. If you’re uncertain about the market, we can guide you through fixed vs. adjustable options, refinancing strategies, and rate lock timing.
Final Thoughts: Stay Ahead of the Curve
While the Fed doesn’t directly control mortgage rates, its influence is undeniable. Understanding how monetary policy affects the lending market gives you a competitive edge as a homebuyer or investor.
Mortgage rates will always fluctuate—but with guidance from SmartKey Lending, you can stay informed, prepared, and in control of your financial future.
