How does the Fed Funds Rate Affect My Mortgage?

With the Federal Reserve (Fed) cutting interest rates, many borrowers believe that this could have a direct impact on their mortgage rate. But does it really? The short answer is no, and other factors should influence whether now is the right time to refinance an existing mortgage or move forward with a new home purchase.

Then What Does?

For borrowers opting for a 30-Year Fixed mortgage,  this rate is largely influenced by the Mortgage-Backed Securities (MBS) market. If you’d like to learn more, we like Investopedia’s definition that you can read here. But a simple definition is that MBS allow investors to access mortgage rates/bonds without having to buy or sell a home themselves. They work similar to a bond and are made up of a bundle of home loans bought from the banks that issued them.

Inflation, along with many other economic indicators such as unemployment levels, the consumer price index (an index of the variation in prices paid by typical consumers for retail goods and other items), home sale data, and others, have a direct impact on the demand for MBS. When these numbers are strong, rates will typically rise, when these numbers are weak, rates will typically drop. 

Fed Funds and 30-Year Fixed

Some housing-related rates such as Home Equity Lines of Credit and Adjustable Rate Mortgages are directly impacted by movement in the Fed Funds rate, but not the 30-Year Fixed. If you take a close look at the chart below, you will notice very little relationship between the Fed Funds rate and the 30-Year Fixed rate.  As a matter of fact, over the three-year duration of this chart, the Fed Funds Rate went up a full 2.0%, while the 30-Year Fixed rate only rose 0.25%.

To drive home the point even further, look at the reaction of the 30-Year Fixed rate during the period of Jan 2017 through Jan 2018. During this time, the Fed increased rates 4 times for a total of 1.0%, and the 30-year fixed rate dropped by 0.375%.  It doesn’t seem logical, but we’ll dig into why this is.

Source: HSH.com

As previously mentioned, the single largest indicator that drives 30-year fixed rates up and down is inflation data. When inflation is higher, investors look for higher yield products, when that happens, investors will move out of their positions in more conservative bonds such as MBS and look to acquire bonds or alternative financial instruments to generate higher returns to stay ahead of inflation.  When there is less demand for MBS the price to acquire those bonds drops, which will cause 30-Year Fixed interest rates to rise.   

Also, worth keeping in mind is that when there is news that the Fed may raise or lower rates, much of the anticipation is priced in ahead of the actual announcement.

A Bird in Hand

In the end, other factors should be of greater influence on whether you should initiate a loan or home purchase. If you’re refinancing, use our handy calculator to determine whether you could save by doing so. Or you may need to free up cash, in which case your need could be greater than waiting on what will or will not happen to rates. If you’re family is growing or you need to relocate, you should do what’s right for you and your family. Ultimately, a small shift in rate has very little impact to monthly payment. If the rate and payment is right for you today, get it locked up and move forward with confidence.  

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10-Year TCM: Treasury Constant Maturity Rate

5 Year ARM: A loan with a fixed rate for the first five years. After that, it has an adjustable rate that changes once each year for the remaining life of the loan.