The term ‘Federal Funds Rate’ is often tossed about in discussions about inflation or the economy, and when changes in that rate pop up in headlines, it’s natural to wonder how they affect home loans. And what, exactly, the Federal Funds Rate is.
What is the Federal Funds Rate?
U.S. banks are required to have a certain level of reserves at the end of every day. When a bank is below its reserve requirement, it must borrow money from another bank with excess reserves. The Federal Funds Rate is the interest rate banks pay to borrow money from each other, and it is stated as a target range set by the Federal Reserve.
Changes in that rate impact interest rates on short- to medium-term loans, such as credit cards, automobile financing, and personal loans. But what about long-term loans, like a mortgage?
How does the Federal Funds Rate affect mortgages?
When the Fed raises rates, it becomes more expensive to borrow money. Likewise, lower rates make borrowing more affordable. Mortgage rates tend to follow these same trends over time, as the Federal Funds Rate influences the overall cost of borrowing, expectations around inflation, and bond markets, specifically the 10-Year Treasury Yield.
The 10-Year Treasury Yield is the interest the U.S. pays investors who lend money to the government. That money is in the form of the purchase of a Treasury note, and the interest paid is used as a benchmark for determining long-term borrowing costs.
“Mortgage rates are more closely tied to the 10-Year Treasury Yield,” says Ellen’s go-to lender, Andy Nolte of Fairway Independent Mortgage Corporation. “This is something we mortgage professionals watch daily, and it influences our decision to lock in a rate on any given day. When the 10-Year Yield goes up, so do mortgage rates and, when it goes down, mortgage rates go down, too.”
Simply put, the Federal Funds Rate mostly impacts short-term interest rates, while the 10-Year Treasury Yield influences interest rates for longer-term borrowing. The interest rate of a long-term loan, like a standard 30-year fixed-rate mortgage, is based on long-term expectations. However, adjustable-rate mortgages are more susceptible to the Fed’s decision-making, so those interest rates change faster and more often.
What economic factors besides the Federal Funds Rate have the biggest impact on mortgage rates?
“Inflation is the arch-nemesis of mortgage rates,” Nolte says. “Inflation makes money worth less in the future. If a lender or bank lends money today at a low rate, they will be paid back with dollars worth less in the future.”
After that, the overall health of the economy helps drive mortgage rates up or down. A strong economy raises mortgage rates, and a weaker one lowers them, like during the COVID-19 pandemic, for example. Lastly, investor demand also causes mortgage rates to rise and fall. When investors buy more bonds, rates fall. When they sell bonds, they rise.
Ultimately, mortgage rates are shaped by a combination of short-term policy decisions and broader market forces. While the Federal Funds Rate plays an important role, factors like inflation, economic conditions, and the 10-Year Treasury Yield ultimately guide long-term borrowing costs. Understanding how these pieces fit together can help borrowers make more informed decisions when timing a home purchase or refinancing.
Andy Nolte has been Ellen’s trusted go-to mortgage lender for years. Working one-on-one with other Brookside locals like Andy is a cornerstone of Ellen’s real estate business. And now with Fairway Independent Mortgage servicing its own loans, the process from start to finish is smoother than ever!
