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The Federal Reserve doesn’t set mortgage rates outright. But its decisions in setting interest rates do play a role in the percentages lenders offer would-be homeowners. And even if the Fed keeps things unchanged, mortgage rates can still fluctuate.
So, overall, how do the Fed’s monetary-policy moves affect mortgages — and influence the cost of borrowing to buy that dream home? Here’s how it all works.
The U.S. Federal Reserve sets borrowing costs for shorter-term loans by changing its federal funds rate . This rate dictates how much banks pay each other in interest to borrow funds from their reserves, kept at the Fed on an overnight basis.
In 2022 and 2023, the Fed increased this key interest rate to help calm inflation — hikes that made it more costly for Americans to borrow money or take out credit.
Fixed-rate mortgages — the most popular type of home loan — don’t mirror the federal funds rate, however; they track the 10-year Treasury yield (more on that below). The fed funds rate does affect short-term loans, such as credit card rates and the rates on new home equity loans and lines of credit .
The Fed also buys and sells debt securities in the financial marketplace. This helps support the flow of credit, which tends to have an overarching impact on mortgage rates.
After 11 rate hikes from early 2022 through mid-2023, the Fed announced — for the eighth straight time — a continued pause at its latest meeting on Wednesday, July 31. That means the federal fund rate remains in a range of 5.25-5.5 percent. “Inflation has eased over the past year but remains somewhat elevated. In recent months, there has been some further progress toward the [Federal Open Market] Committee’s 2 percent inflation objective,” the Fed said in a statement.
While earlier this year the Fed had indicated it planned to cut rates in 2024, an actual reduction keeps getting pushed farther into the future. “Much like that flight where departure keeps getting delayed 15 minutes at a time with no end in sight, the timetable for when the Fed begins to cut rates is equally uncertain,” says Greg McBride, CFA, Bankrate chief financial analyst.
However, at this meeting the central bank did hint that it’s getting closer to a long-awaited reduction in rates, perhaps as soon as September (when the Committee next gathers). To extend the airline analogy: The plane is at the gate, and the flight crew is about to board.
Fixed-rate mortgages are tied to the 10-year Treasury yield. When that goes up or down, fixed-rate mortgage rates follow suit.
The fixed mortgage rate isn’t exactly the same as the 10-year yield, however; there’s a gap between the two.
Typically, the gap between the 10-year Treasury yield and the 30-year fixed mortgage rate spans 1.5 to 2 percentage points. For much of 2023 and 2024, that margin grew to 3 percentage points, making mortgages more expensive.
While fixed-rate mortgages dominate the U.S. residential financing scene, some Americans prefer adjustable rate mortgages (ARMs), which have variable interest rates that reset annually or semi-annually. The Fed’s moves can affect them more directly.
More specifically, the rates on ARMs are often tied to the Secured Overnight Financing Rate, or SOFR. Because the Fed’s rate decisions serve as a basis for savings instruments, raising or lowering the fed funds rate can push the SOFR up or down. ARM rates, in turn, go up or down as well when the rate resets.
All this means that, if the fed funds rate goes up, your ARM rate will increase as well at the next adjustment.
Regardless of current Federal Reserve policy, your best bets for the lowest possible mortgage rate are to maintain solid credit, keep your debt low, make as much of a down payment as you can and shop around for loan offers.
When comparing rates, take a look at the APR, not just the interest rate — some lenders might advertise low interest rates, but offset them with high fees. You’ll know your true all-in cost, including these fees, by understanding the APR.
The Federal Reserve doesn’t determine fixed mortgage rates. But its policy decisions weave into the broader economic picture that informs and influences your borrowing costs. When setting fixed rates, mortgage lenders take the Fed’s moves into account, as well as factors like the 10-year Treasury yield, inflation and investor appetite. And the Fed’s changes to its benchmark borrowing rates will impact the indexes that influence ARM rates as well.
Arrow Right Principal writer, Home Lending
Jeff Ostrowski covers mortgages and the housing market. Before joining Bankrate in 2020, he spent more than 20 years writing about real estate, business, the economy and politics.
