How the Federal Reserve Affects Mortgage Rates
Buying or renting a home can lead to confusion, anxiety, and frustration. Many homebuyers do not understand how mortgage rates are calculated, but they often feel the impact of increased mortgage rates. While mortgage rates can be frustrating, so can rises in rent costs. If you are looking to buy a home or debating between buying and renting, it is important to understand how the Federal Reserve Affects Mortgage Rates.
What is a mortgage rate?
When you borrow money to purchase a home from a lender, such as a bank or financial institution, you will also agree to a mortgage interest rate. The mortgage interest rate is the amount of money you pay in addition to the loan principal, and it directly impacts your monthly payments. With the costs of homes being in the hundreds of thousands of dollars, even a slight increase in the mortgage interest rate can send your monthly payments through the roof. On the other hand, lower interest rates can provide the break some potential home buyers need to purchase their first home.
There are so many factors that go into determining the mortgage interest rate at any given time. Some of these factors are controlled by the borrower, such as credit score, down payment, and property location. Other factors rest with the lender, such as the loan type, loan term, and interest rate type. Many home buyers also look at the Federal Reserve as a determining factor for mortgage rates. But, how big of a part does the Federal Reserve play in setting mortgage rates?
The Federal Reserve does not set mortgage rates.
This is a common misconception among home buyers when it comes to mortgage rates. The Federal Reserve actually sets the Federal Funds rate, which is an overnight lending rate for banks and other financial institutions. A higher Federal Funds rate means that it is more expensive for banks to borrow money from other financial institutions.
Short-term adjustable-rate mortgages and variable interest rates are most directly impacted by the Federal Funds rate. These rates will rise or fall based on the decisions of the Federal Reserve. If a bank has to pay a higher rate to other banks in order to borrow money, they typically pass that additional cost on to their clients as well. Consumers may experience the following when the Federal Funds rate increases:
· Increased interest rates on lines of credit
· Higher interest rates on auto loans
· Possible higher interest rate on mortgages
The Federal Reserve does impact mortgage rates, to some degree.
An increase in the Federal Funds rate alone is not enough to directly cause an increase in mortgage rates. Again, the Federal Reserve is not responsible for setting mortgage rates. However, that does not mean their decisions are isolated from mortgages.
Whenever the Federal Reserve lowers the Federal Funds rates, borrowers utilizing variable-rate loans get the most benefit. Their home equity lines of credit or adjustable-rate mortgages can become less expensive. The results will likely not be instant, but some benefit will come over time.
Fixed-rate mortgages are aligned with market rates.
The Federal Reserve’s decisions can send a message to lenders and home buyers. Whether they lower or raise Federal Funds rates, can be perceived as the Fed promoting growth in the U.S. markets or not. This decision can indirectly impact mortgage rates in some way as markets react.
The Federal Reserve typically lowers interest rates if they perceive that the economy is slowing or may slow in the near future. Lower rates encourage businesses to invest and consumers to spend. The goal of lowering rates is to propel economic growth. However, sometimes the Fed feels that the economy is growing too fast. In order to combat this, they raise interest rates in an attempt to slow financial decisions.
While mortgage rates may not receive a direct hit from the Federal Reserve, home buyers do. Their businesses could prosper or suffer based on the Fed’s decision. They may have more money to save for a down payment, thus lowering their overall mortgage rate. Or, buyers could have less than usual and be unable to make higher monthly payments. The Federal Funds rates impact the following things that play into home buyer’s decisions.
· Credit card rates
· Savings rates
· CD rates
· Home equity line of credit
· Short-term adjustable rates
· Auto loan rates
Lower rates encourage spending and can make it easier for potential home buyers to achieve their goal of home ownership. Higher rates can lead to decreases in spending and significant financial cuts. People on a tighter budget are less likely to commit to a mortgage loan and high interest rate.
Slight changes in interest rates make big changes in cost.
Homes are expensive. The loan principal for a home is already a major cost but factoring in the mortgage rate can raise monthly payments significantly. An increase as small as 1% in mortgage rates can lead to more than $100 extra per month on mortgage payment. If mortgage rates are up, people tend to delay purchasing a home. They fear they cannot maintain the monthly payments, or they do not have enough for a down payment large enough to reduce their rate. Either way, home ownership and purchasing decreases.
When home buying decreases, people may opt to continue renting a home instead of buying. This pattern of behavior can drive up the cost of rent due to increased demands. Higher rent leads to more financial strain and frustration and can actually cause consumers to research purchasing a house again.
Rent spikes can also cause a decrease in the cost of a home. With so many people choosing to rent instead of buy, people selling their homes may lower the cost in order to attract buyers. While mortgage rates may still be high, a lower loan principal can greatly reduce monthly payments.
In short, mortgage rates follow a weird and complicated cycle.
The Federal Reserve may have some impact on mortgage rates, but there are more factors than we can count that determine rates. A home buyer’s down payment, credit score, home location, and more can all raise or decrease their mortgage rate. There are also a wide range of factors controlled by the lender and determined by the current housing and rental markets that affect interest rates.
Overall, home buyers should research current mortgage rates and shop around to find the right lender and rate for their budget. A mortgage expert, such as Jill Burgess of Mortgages by Jill, can help you navigate the difficulties of mortgage rates. She can understand your unique loan situation and determine the best cost of action to meet your financial needs.
Brought to you by: Ameris Bank Mortgage Service / MortgagesWinstonSalemNC