The financial community is always talking about “The Fed” and speculating whether or not they will raise rates.
What exactly does this mean? And what does it have to do with mortgage rates?
The Federal Funds Rate (short-term interest rate) is the rate at which banks loan to each other. The Federal Reserve System is the central bank of the United States, whose function is to create a safe, flexible and stable financial system.
The decision to raise rates or not, is dependent upon economic variables such as inflation expectations, global weakness, employment / wage data and more.
To clarify, mortgage rates are NOT dictated by The Fed.
Fed Rates effect: credit card rates, interest on savings & money market accounts, CDs and short-term loans.
The confusion arises because 1-5 year ARMs (Adjustable Rate Mortgages) follow the one year treasury index which reflects the Fed Funds Rate. With these types of loans then, payments can increase if rates increase.
Long-term loan rates are determined by private investors on the free market who buy and sell bonds.
Misunderstanding also occurs because Fed Rate changes can indirectly affect mortgage rate activity due to financial market movements. Fed decision speculations and uncertainty influence investor sentiment and decisions. This results in mortgage rate volatility. However, rates stabilize after movement from knee-jerk market reactions.
The Fed does influence mortgage rates through the decision of whether or not to buy mortgage bonds, increasing demands for these investments, which keeps mortgage rates down. If the Fed sells bonds, mortgage rates can go up.
Sometimes, a Fed rate hike can help long-term mortgage rates. There are many variables to consider and differing points of view about the best approach.