You likely saw the news recently that the Federal Reserve lowered the federal funds rate for the first time since 2020.

The federal funds rate determines the cost to banks for borrowing. It trickles down to affect all kinds of lending, including mortgages, auto loans and credit cards.

If you’re curious about how the Fed’s actions influence your homebuying or refinance decisions, read on as we look at what the Fed does and why it matters to you.

What is the Federal Reserve?

The Federal Reserve System, often called “the Fed,” is the central bank of the United States.

The Fed’s mission is to maintain a stable and healthy economy, and it primarily accomplishes this by adjusting the federal funds rate.

Raising or lowering the funds rate is an attempt to either cool down the economy or stimulate growth, depending on their goal at any given time.

The Federal Reserve’s mandate

The Fed’s goals are often referred to as the “dual mandate,” which includes:

1. Controlling inflation: If inflation is rising too quickly, the Fed typically raises interest rates to try to tame it.
2. Promoting maximum employment: If unemployment is high and the economy struggles, the Fed will lower rates to encourage borrowing, investments and business growth.

To maintain the work the Fed has done to balance a post-pandemic economy, it recently decided to lower the funds rate and stimulate economic activity.

What are the different types of interest rates?

An interest rate is the cost to borrow money. It determines how much extra you’ll pay a lender back on top of the original loan amount.

There are several different types of interest rates, including:

• Federal funds rate: The interest rate at which banks lend to each other overnight, established by the Federal Reserve. This rate is not directly applied to consumer loans or mortgages, but it influences other economic interest rates.
• Prime rate: The interest rate that commercial banks charge their most creditworthy borrowers (typically large corporations).
• Mortgage interest rates: The rates charged by lenders on home loans. Rates for mortgages can be fixed or adjustable.
• Savings account interest rates: The rates that financial institutions pay consumers for depositing money into savings accounts.
• Credit card interest rates: The rates that consumers pay on outstanding credit card balances, often identified as APR (annual percentage rate).
• Auto loan rates: The rates for financing a vehicle purchase.

Each of these interest rates is influenced by the Fed’s actions and broader economic conditions.

The Fed doesn’t even directly set the funds rate; it establishes a target range for the rate and uses tools like Open Market Operations (OMO) to influence it.

How Fed rate hikes or cuts impact mortgage interest rates

As with other interest rates, mortgage interest rates are not directly affected when the Fed raises or lowers the funds rate but are influenced by it.

For example, lenders often adjust rates before the Fed’s announcement based on the Fed’s forecasts.

Mortgage rates, especially for fixed-rate mortgages, are actually more closely tied to the yields on long-term bonds, like ten-year U.S. Treasury notes.

The effect of Fed decisions on fixed-rate and adjustable-rate mortgages

The impact of Fed hikes or cuts varies depending on the type of mortgage.

Let’s take a look at how fixed-rate and adjustable-rate mortgages (ARMs) are impacted:

• Fixed-rate mortgages: The interest rate remains the same over the life of the loan, which means that once a borrower locks in their rate, they are protected from any rate changes regardless of what the Fed does.
• Adjustable-rate mortgages: ARMs offer a lower initial interest rate for a fixed period, then adjust periodically based on a benchmark (or reference) rate (which serves as the basis for a variety of loans). When the Fed adjusts rates, homeowners with ARMs may see their mortgage payments rise or fall during the adjustment period based on the Fed’s actions.

Because of their nature, ARMs are more immediately affected by the Fed’s rate adjustments, which can be either positive or negative, depending on whether the Fed’s adjustments are up or down.

While existing fixed-rate borrowers won’t be impacted by Fed rate decisions, prospective homeowners and those who want to refinance their current mortgage should be aware of upcoming announcements and their influence on rate changes.

Other factors that influence mortgage interest rates

Mortgage interest rates are influenced by various factors beyond the Fed’s actions, including bond markets and individual lender decisions.

Let’s look at some of these other factors.

Bond markets and investor sentiment

As previously mentioned, mortgage rates are closely tied to the yields on ten-year U.S. Treasury notes. When bond yields rise or fall, mortgage rates tend to head in the same direction. 

The way investors perceive the economy also plays a role in this dynamic. If the economy is perceived as stable, investors are more likely to move to riskier assets, which tends to raise bond yields. In uncertain times, investors seek safer investments like bonds, thus lowering yields on bonds.

Inflation expectations also impact bond yields, with rising inflation leading to higher yields and mortgage rates.

Global economic conditions

Events and trends from around the world can also impact mortgage rates.

A recent example is the COVID-19 pandemic, which drove down interest rates as investors sought safer investments.

Mortgage lenders

Mortgage lenders aren’t just watching what the Fed does to determine how they set rates.

They take into account a wide range of factors, including:

• The cost of borrowing
• The borrower’s credit score, loan amount and other financial factors
• Lender competition and demand
• Inflation expectations

What homeowners and buyers need to know about interest rate cuts

The Federal Reserve typically meets eight times per year, and any upcoming announcements can indicate where mortgage rates may be headed.

Watch the main economic indicators, such as inflation, employment reports and housing market trends, to get clues about future rate movements.

Finally, focus on long-term affordability rather than the “perfect timing” to buy a home or refinance—and lock in a rate as soon as it fits your needs!

Compass Mortgage: Your lending partner and advocate

Do you want to take advantage of the current lower mortgage rates?

Compass Mortgage’s distinctive Get Committed® program will put you in the best possible position to win your desired home.

With Get Commited®, we provide a fully underwritten loan commitment and lock in your interest rate before you even find the property you want to buy.

And if you’re a current homeowner looking to refinance, check out our rate-and-term and cash-out options!

Apply now to start the homebuying process!