Contrary to popular belief, the Federal Reserve doesn’t set mortgage rates. The central bank’s decisions impact financial products like CD rates and savings accounts much more directly than they do mortgage interest rates.
Why Mortgage Rates are Sometimes Lower Than the Fed Rate
However, mortgage interest rates have increased alongside the interest rate hikes from the Fed. If the Federal Reserve isn’t entirely responsible for the increases, why have mortgage rates risen in 2022? Why are mortgage rates sometimes lower than the Fed rate?
The answers require a quick exploration of the federal funds rate.
What is the Federal Funds Rate?
The federal funds rate is used by banks when lending money to other banks overnight. Law requires that banks have a minimum reserve amount proportional to their deposits.
The reserve is housed at a Federal Reserve Bank. Banks with excess reserve requirements may lend funds overnight to banks with reserve deficits.
The first question the average home buyer might ask is: how does the federal funds rate affect mortgage interest when it’s a rate used between banks?
When banks must spend more money to borrow from other banks, they pass those costs on to consumers through interest rate hikes on products like lines of credit and auto loans. Mortgages are affected, too, but indirectly, by changes in the federal funds rate.
How Mortgage Rates Increase with the Fed Rate
The federal funds rate doesn’t directly impact the mortgage market, but it does influence it. In fact, mortgage rates may rise even before the fed moves on interest rates.
A group known as the Federal Open Market Committee, made up of the Board of Governors of the Federal Reserve System and others in similar roles, meets every so often to discuss whether it’s time to implement a rate hike or reduction.
Rate hikes cool the economy, and rate reductions fuel spending. Or that’s how it’s supposed to work. In 2022, the Fed has increased its rate several times to combat inflation. As of September 2022, it’s not yet clear whether their actions have succeeded.
Interestingly, the word usually gets out before these FOMC meetings as to whether the group will increase interest rates. These rumblings typically affect mortgage rates even before the Fed makes an official announcement.
Other Key Factors
However, other factors also influence mortgage rates, like the overall health of the U.S. economy, the global economy, and the health of the real estate market. The Fed’s impact on interest rates is often a response to current economic conditions, and mortgage rates have already moved in response to it.
By the time the Fed gets around to officially changing rates, mortgage rates have already recalibrated according to the health of the economy. Sometimes that recalibration is in direct opposition to the interest rate moves from the FOMC.
In early August 2022, the average mortgage rate was actually lower than 5 percent, but it bounced up to 5.55 percent by the end of the month. What can we learn from these changes? The economy is in a volatile place right now, and mortgage rates are anything but predictable.
What About the Fed Funds Rate and HELOCs?
Since the federal funds rate impacts the interest rates of products like CDs and savings accounts, as well as mortgage rates, it stands to reason that HELOC rates would also rise and fall with the Fed’s actions.
In fact, the fed rate impacts HELOCs more directly than mortgages, and rates move up or down whenever the Fed makes a move. HELOC rates come from the Wall Street Journal prime rate, which the paper bases on the federal funds rate.
Homeowners with HELOCs should expect their adjustable rates to increase when the federal funds rate rises. It may benefit homeowners to keep an eye on the financial markets, which usually offer clues as to future rate hikes. Homeowners can prepare for higher payments by allocating funds before an official rate increase.
Financial Health of Borrowers Impacts Rates
Looking at current mortgage interest rates is just part of the puzzle for any future homeowner who needs to secure a mortgage. For each borrower, average mortgage rates are just a starting point in the application process. Actual rates also depend on credit score, loan-to-value ratio, and debt-to-income ratio.
Contact Peak Finance as your Los Angeles mortgage broker to learn more.
