Federal Reserve Affects Mortgage Rates

One of the biggest questions buyers are having to ask themselves in this current housing market is: should I buy or should I rent? Considering the colossal increase in home prices in the United States in 2021, this question has gotten harder to answer. The debate gets even more challenging with the forecast of three Federal Reserve rate hikes priced into 2022. The last time we saw something like this was the real estate market in 2018, when the Federal Reserve raised interest rates four times, after raising three times in 2017. With interest rates expected to increase in the following years, here is how the Federal Reserve affects mortgage rates.

Many of the buyers in todays real estate market are millennials trying to become first-time homebuyers. That being said, any alteration to affordability directly impacts the purchasing power of this group. Changes in affordability can stem from rising prices and rising mortgage rates. With many first-time homebuyers still looking to make the step to homeownership, they may be wondering how the Federal Reserve affects mortgage rates. First-time homebuyers and renters looking to take the next step wonder if the raising of benchmark interest rates will impact their affordability. Renters are not only frustrated by rising rents and home prices, but they may also be losing hope that they can buy before rate increases.

How The Federal Reserve Affects Mortgage Rates

One common misconception by homebuyers and Facebook economists is how the Federal Reserve actually affects mortgage rates. Surprisingly, the Fed does NOT set the 30-year mortgage rates. The Federal Reserve determines the federal funds rate, which has direct ties to short term and adjustable interest rates. The federal funds rate is described best as the rate at which banks and financial institutions lend money to each other overnight. These corporations do this in order to meet mandated fund reserve levels. With that being said, a higher federal fund rate leads to higher costs for financial institutions to borrow from each other. As we have seen with inflation, those prices are passed onto the consumers in forms of higher interest rates. These rates can run from HELOC, auto loans, and in some ways, mortgages.

Traditional mortgages do not directly relate to this overnight borrowing either. In fact, mortgage rates stem from many factors, including the Federal Reserves monetary policies. The reason mortgage rates are so low today is because the Federal Reserve has been extremely accommodative. This is due to $40 billion a month in purchases of MBS (mortgage backed securities) and $80 billion U.S. treasuries monthly. With the Fed talking about tapering, mortgage rates will ultimately begin to tick up as the economy remains hot. But you still may be asking, how does rising federal funds rates affect home prices?

Federal Reserve Rate Increases Mean More Expensive Home Loans

With interest rates set to increase, mortgage rates will follow. This will ultimately lead to mortgage loans being more expensive. With higher rates, loans will cost thousands more in coming years, especially over a 30 year timeframe. Even the slightest increase in interest rates can have SIGNIFICANT impact on costs for homebuyers. Not only will home loans begin to cost more, but rents will also increase. Renters will look forward to paying more to their landlords. Landlords will begin charging more for market rent in order to cover the costs of higher mortgage loan costs.

Federal Reserve Rates And Home Prices

Some may be wondering how rising interest and mortgage rates will affect home prices. Well, lucky enough for some, they may lower prices. In a perfect market, mortgages costing more will typically balance out with sales prices of homes. However, in our current seller’s market with low inventory, home prices will probably not decline. Home prices look to increase according to experts, however, at a slower rate than before. While no one truly knows what will happen until it does, many signs point towards home prices still increasing.

Because of higher rates, mortgages become less affordable on the month-to-month basis. When mortgages get more expensive, buyers are harder to find. When buyers are harder to find, typically home prices stall. And finally, higher rates can actually depress price growth in homes. In order to lure in buyers who are not completely out, many sellers consider lowering asking prices.