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How The Fed Raising Rates Affects Mortgages

Kevin Graham6-minute read

April 25, 2022

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The economy has gone through several major changes in recent months. After taking a hit as a result of the pandemic, supply chain concerns and rising oil prices have created a new problem to worry about: inflation.

One of the primary tools the Federal Reserve, or the Fed for short, has for controlling inflation is to raise short-term interest rates. But when the Fed raises rates, how does that impact consumer loans like mortgages? If you’re looking for a mortgage, what do you need to know? Before we get there, let’s get back to basics.

What Is The Fed Funds Rate?

We generally think of interest rates as being consumer focused. The interest rate helps determine the amount the bank is charging you over time for a loan. But banks borrow money from each other as well. They have to maintain a certain amount of reserves and also keep up their day-to-day lending operations.

The interest rate at which banks borrow money from each other overnight is referred to as the federal funds rate or simply the fed funds rate. This is regulated by the Federal Reserve. The important thing to know here is that this rate usually serves as a benchmark interest rate for the prime rate that banks give their most well-capitalized clients. (Think large corporate accounts with low risk of default.)

From the prime rate, banks then set all the other interest rate buckets for different types of consumer loans. The rate an individual consumer will get is also affected by other qualifications such as down payment and credit score.

But the base rates consumers get are almost always derived from the federal funds rate. In this way, the fed funds rate impacts every other consumer and business interest rate.

When Will The Fed Raise Interest Rates?

Unless you’re Biff Tannen in “Back to the Future Part II” with access to scores for sporting events that haven’t happened yet, predicting the future is foolhardy. The Federal Reserve has in recent years gone out of its way to try to telegraph what’s going to happen with interest rates, but the moves of the Federal Open Market Committee (FOMC) are still subject to change as the world evolves.

Before we get into what may happen in the near future, it would probably be good to provide a little context on the history of interest rates in the mortgage space. Economic conditions of the past can sometimes illuminate what’s happening in the present.

The first reliable data we have on mortgage rates comes from Fannie Mae who started tracking this in 1971. Over the past decade, we’ve gotten used to long periods where average 30-year fixed rates were no higher than 5% for any appreciable length of time. However, in the ’70s, rates were anywhere between 7.5% – 9%.

In the late 1970s through much of the 1980s, the United States was dealing with an oil embargo put in place by the Organization of Petroleum Exporting Countries (OPEC). The OPEC embargo caused gas prices to shoot way up, which in turn had a knock-on effect on most other prices because the movement of goods and services requires transportation. This led to hyperinflation, extremely fast price increases.

To combat this, the Federal Reserve increased short-term interest rates. As mentioned before, when this happens, all rates go up. While the annual average rate was around 10% during the decade, they reached as high as 16.63% in 1981 at the height of the inflation crisis.

By the 1990s, inflation came back down a bit and interest rates were coming in under 7% by 1998.

The early aughts saw September 11, and for a while, the economy was in a funk to go along with the sorrow experienced across the country. Rates fell from around 8% to near 5%. Later in the decade, rates went down further as the federal government stepped in in multiple ways to stabilize the housing market after turmoil seen in 2008-09.

The early teens were kind of an extension of the interest rate period beginning in 2008, meant to stimulate economic recovery. Mortgage rates went up a bit in 2014 for reasons other than short-term interest rates. (The Federal Reserve also impacts mortgage rates through mortgage bond purchases.)

But between factors including Britain’s exit from the European Union and presidential election results that weren’t anticipated, at least by many major investors, rates stayed fairly low on the mortgage side.

The most recent rock-bottom mortgage rates have come as the Federal Reserve lowered the federal funds rate to near zero in response to the pandemic.

That brings us to now. Mortgage rates have started to trend up again because the Federal Reserve is raising the federal funds rate to combat inflation. The most recent reading of the Consumer Price Index, a major inflation indicator, showed prices up 8.5% over the last 12 months.

There are multiple reasons for inflation being as high as it is right now. One of the big ones is supply chain disruption as a result of a slow comeback from lockdowns. The second is that the government cut checks to many Americans with the idea that they would put the money back into the economy. If you have more money to spend, you are willing to spend more, and prices go up. Most recently, there’s been a shock to global oil supplies as a result of sanctions against Russia for its invasion of Ukraine.

The economy is a complicated beast, and there’s no one thing you can point to, but the Fed wants to get inflation under control. There was a 0.25% increase in the federal funds rate target range in March, and many Fed governors are foreshadowing more aggressive hikes over the next several months if current conditions hold.

Great news! Rates are still low in 2022.

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How Does The Fed Rate Rise Affect Mortgages?

When the Fed funds rate goes up, interest rates tend to go up for all consumer borrowing. Mortgages are a little bit unique in that the rates are based on mortgage-backed securities (MBS), which are traded on the bond market. Mortgage rates are most directly impacted by the yields on these bonds, and these depend on investor appetite.

However, MBS sales don’t exist in a vacuum. Because the Fed raises short-term interest rates, the rates of return earned by investors on all sorts of financial instruments go up. Because of this, yields on MBS tend to go up to continue to attract investors. As a result, mortgage rates end up rising.

What Should I Do After The Rates Rise?

If you’re in the market for a mortgage right now, the way you react to this depends on your goals and the urgency you have around them. It’s certainly not the time to panic.

If you’re a home buyer and you want or need to buy now, it’s absolutely doable. You just have to make sure you fully understand your budget and what you can realistically afford. You’ll be paying a slightly higher finance cost for a house in the same price than you would 6 months ago.

On the flip side, if you’re not ready now, there may be a silver lining. As more buyers are priced out of the market, competition may come down. If this happens, sellers may lower prices as they see their homes sitting on the market for a longer period of time.

If you’ve refinanced for the purposes of getting a lower rate at any time in the last several years, it’s hard to see getting a lower rate for the same term, but many people choose to pay off their mortgage faster. The shorter your term, the lower your rate.

If you’re looking to take cash out, the good news is home values keep rising right now. That means homeowners are sitting on top of a lot of equity. This could mean the opportunity for you to convert that equity into cash for your own purposes.

Whether you’re looking for financing for a home improvement or trying to consolidate debt, one thing to keep in mind as rates rise is that mortgages always remain some of the cheapest financing you can get as a consumer. So for the right situation, refinancing still makes a lot of sense.

The Bottom Line

When the Federal Reserve raises the federal funds rate, all consumer interest rates, including those for mortgages, tend to go up with it. Spurred to action by inflation this time around, the Fed is looking to aggressively move the rate up. Although rates are on the rise, buying or refinancing in this market can still makes sense. You just need to be mindful of your situation and goals.

If you’re ready to get a mortgage, one way to protect yourself from rising interest rates is to lock your mortgage rate. To get started, apply online or give us a call at (833) 326-6018.

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Kevin Graham

Kevin Graham is a Senior Blog Writer for Rocket Companies. He specializes in economics, mortgage qualification and personal finance topics. As someone with cerebral palsy spastic quadriplegia that requires the use of a wheelchair, he also takes on articles around modifying your home for physical challenges and smart home tech. Kevin has a BA in Journalism from Oakland University. Prior to joining Rocket Mortgage, he freelanced for various newspapers in the Metro Detroit area.