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- The Federal Reserve slows inflation by raising the federal funds rate, which can indirectly impact mortgages.
- High inflation and investor expectations of more Fed rate hikes can push mortgage rates up.
- If investors believe the Fed may cut rates and inflation is decelerating, mortgage rates will typically trend down.
The Federal Reserve announced following the close of its March meeting that it will keep the federal funds rate steady for now. It also indicated that it still expects to cut rates three times this year. But we'll likely need to wait at least a few more meeting before we get the first cut.
As inflation slows and the Fed is able to cut its benchmark rate, mortgage rates should go down in 2024. But if inflation doesn't come down any further, the Fed would likely keep rates higher for longer, keeping mortgage rates elevated as well.
Mortgage rates have increased in recent months. Though inflation has dropped substantially since it peaked in 2022, it sped up a bit in February, according to the latest Consumer Price Index data. The longer it takes inflation to slow, the longer we'll have to wait for lower mortgage rates.
Changes to the federal funds rate often have a big, if indirect, impact on mortgage rates. That's why, if you have a mortgage or are planning to get one, it's a good idea to know what the Federal Reserve does. Though it can be a bit of a boring topic, Fed policy decisions have a lot of real-life implications for everyday people, especially current and future homeowners.
When the Fed decides to make changes to its benchmark rate, called the federal funds rate, it can indirectly impact the kinds of rates you're offered from mortgage lenders. This will in turn impact how much you pay each month for a home.
What the Federal Reserve does
The Fed has two main jobs, called its "dual mandate": maintain price stability and keep unemployment low.
When the economy heats up too much, prices tend to grow faster than is healthy. When this happens, the Fed uses monetary policy tools that put downward pressure on inflation. Its primary tool for slowing inflation is the federal funds rate, which is the interest rate banks charge each other to borrow money overnight. Increasing this rate slows economic growth.
When the economy has slowed too much and needs a boost, the Fed will cut the federal funds rate to make it cheaper for banks to borrow money. During the COVID-19 pandemic, the Fed reduced rates to near zero to stimulate a struggling economy.
The federal funds rate
In 2023, the Fed increased the federal funds rate four times:
- February: +0.25 percentage points
- March: +0.25 percentage points
- May: +0.25 percentage points
- June: no change
- July: +0.25 percentage points
- September: no change
- November: no change
- December: no change
At its first meeting of 2024, the Fed kept rates steady:
- January: no change
- March: no change
The Fed spent most of 2022 aggressively raising rates to try to tame decades-high inflation. Its efforts have been paying off — the Consumer Price Index, a major measure of inflation, has come down substantially from where it peaked in June 2022.
As long as inflation continues to slow, the Fed may finally start considering rate cuts at its upcoming meetings. Right now, investors believe it's possible we'll get at least one cut by June, according to the CME FedWatch Tool. But this hinges on the latest economic data continuing to show that the economy is coming into better balance.
How mortgage rates are determined
Your own personal mortgage rate will depend a lot on the circumstances of your financial profile: your credit score, debt-to-income ratio, and how much you have for a down payment.
But larger rate trends in the mortgage market can be impacted by a lot of different factors, including current economic conditions, inflation, the unemployment rate, and the housing market.
Mortgage rates don't directly follow the federal funds rate. Instead, they typically move up and down with 10-year Treasury yields, because mortgage rates are largely impacted by investor demand.
"Fixed mortgage rates are typically set based on the yield of the 10-year Treasury bond," says Michael Gifford, CEO and co-founder of Splitero, a home equity investment company. "This bond is usually the most closely monitored by investors. As the Federal Reserve raises short-term interest rates, the yield on the 10-year Treasury bond also tends to rise. This puts upward pressure on mortgage rates. The Fed's rate hikes can also signal to lenders that inflationary pressures may be increasing, which can lead lenders to raise their interest rates in response, including mortgage rates."
Fed rate hikes don't directly impact mortgage rates — but investor expectations can
After a consumer closes on their mortgage, it's typically sold and packaged into a type of bond called a mortgage-backed security (MBS), which investors can then purchase.
When inflation is high, lenders need to raise rates to entice investors. This is because high inflation erodes the returns on their investments, so they demand higher yields.
Conversely, if it looks like we're headed for a recession, investors will flock to safer investments, including mortgage-backed securities. This can send mortgage rates lower as lenders look to attract borrowers.
Why might investors think a recession is imminent? If the Fed raises rates too high and too quickly, there's a risk it could slow the economy too much. Many experts have expressed concerns that the central bank won't be able to succeed in its attempt to make a "soft landing," where it slows the economy enough to bring price growth under control but not so much that it inadvertently induces a recession. However, that's started to look more achievable in recent months.
Essentially, investors look to the Fed to see how it's reacting to current economic conditions, and they make investing decisions based on how they think the Fed's actions will impact the broader economy.
How Fed rate hikes impact you and your mortgage
"Any homeowner with a mortgage, a homeowner looking to refinance their mortgage, or a future homeowner looking to purchase a home should keep a close eye on interest rates," Gifford says.
Though mortgage rates don't always move in lockstep with the federal funds rate, its a good idea to have a basic understanding of when and why Fed policy moves might impact mortgages — especially if you're planning to get a mortgage or refinance sometime soon. This means not only watching what the Fed does, but also what its officials say about future policy changes.
Fed officials have indicated they're ready to start cutting rates this year. This would likely allow mortgage rates to fall. But in the meantime, borrowers should expect mortgage rates to remain near their current levels.
The Fed and mortgage rates frequently asked questions
Mortgage rates may increase when the Fed rate goes up, but it depends on what's going on in the broader economy that's spurred the Fed to raise rates. If investors who purchase mortgage-backed securities believe that inflation will continue to grow based on the Fed's actions and statements, mortgage rates could rise along with the federal funds rate.
Mortgage rates may decrease when the Fed cuts the federal funds rate, but this depends on other economic trends. Mortgage rates tend to go down when the economy isn't doing well, and the Fed typically cuts rates as a way to help a slow economy.
Mortgage rates aren't tied to the Federal Reserve's federal funds rate, and the Fed doesn't set mortgage rates. Mortgage rates typically move up or down along with the 10-year Treasury yield. Mortgage rates can be impacted by Fed policy decisions and investor expectations around how those decisions will impact the economy, though.
If you have a fixed-rate mortgage, your mortgage rate will stay the same until you sell your home, refinance your mortgage, or pay off the loan in full. If you have an adjustable-rate mortgage (ARM), your rate adjusts periodically based on current market rates, which can be impacted by the Fed rate.
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