How The Fed Funds Rate Impacts Mortgage Interest Rates
With inflation rising, all (economic) eyes are on the Federal Reserve and what it will do with the federal funds rate.
For those in the market to buy and/or sell a home, they should want to know how the fed's actions will impact them. They should want to know about the fed's stance on buying or selling mortgage-backed securities and how the fed's overall outlook will impact what consumers will pay to borrow money for a home.
When the cost of borrowing goes up, home affordability declines. Currently, the fed has shown signs that the federal funds rate will rise several times before this year is through. And that got me wondering, how will a rise in the fed funds rate impact mortgage interest rates?
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The Federal Reserve And Mortgage Interest Rates
If you google both the federal reserve and mortgage interest rates, you will quickly learn that the Federal Reserve does not set mortgage interest rates. You'll also discover the many variables that help determine the direction of mortgage interest rates, and after a short while of reading, you will come to the realization that you really haven't learned much.
This is why I like to look at data. Plot two sets of data, and try to find a correlation. In the graph below, I have plotted the Federal Funds Rate and mortgage interest rates over time. The results are telling!
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Fed Funds Versus Mortgage Rates
The graph below plots more than 50 years of the 30-year fixed-rate mortgage in blue and the effective federal funds rate in red. The dashed lines reveal the ten-year average of each while the yellow-highlighted dashed line plots the difference between the two rates.
For the past 30 years, we've seen the trend of the difference between the two rates remain very stable, typically with mortgage interest rates marked up 3% to 4% over the federal funds rate.
Now all the websites in google's database might tell us there is no direct correlation between the two, I think savvy homebuyers and sellers should take note and expect to see mortgage interest rates rise along with the growth of the federal funds rate.
When you see the Fed Funds Rate rise, expect a near-term rise in mortgage interest rates (unless the market already made the move in anticipation of the Fed's rate hike).
Let the experts continue to rebuke those that say they are directly related, but I'm going to follow the historical data and have the expectation that mortgage interest rates are pushing higher for the foreseeable future.
The Federal Reserve has made it clear and certain that they will be raising the fed funds rate several times this year, and history tells us that we should expect the mortgage market to follow suit.
In an opinion published last summer, one Fed committee member said using the traditional model for determining the proper Federal Funds Rate, today’s fed funds rate should be close to 5%. If the Fed acted on that, a federal funds rate of 5% would suggest mortgage interest rates moving above 8% over the next year or so. While I do not expect that to happen anytime soon, we do need to know that the Fed cannot (and will not) sit on its hands forever. The small token increases in the fed funds rate this year will become larger ones if inflation does not return near the targeted 2% level.
If you are planning a move now or in the near future, and you plan to finance the move, history supports taking immediate action. The supply of homes is too low so we know that home prices will continue to rise, and now the fed has signaled its plan that will ultimately result in the rising cost to borrow money.
Get yourself into a home at today's prices and today's cost of funds so that you can avoid the largest hit to home affordability that I will have observed in my 30-plus years of selling homes. One day you will look back at this as a time of opportunity, and those that took action came out strong.
There are a lot of people who endorse Joe for the job of selling your home, from Barbara Corcoran (Star of ABC's Shark Tank) to Preston Scott (host of Tallahassee's top daily "Audio Magazine," as well as the thousands of happy customers Joe has helped in the past. Listen why!
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