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How the Federal Reserve Affects Mortgage Rates

When the Fed hikes rates, borrowing gets more expensive -- but there's a silver lining.

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The Federal Reserve raised interest rates this week, but that might not mean much for already volatile mortgage rates.

The Federal Reserve doesn’t directly set mortgage rates, but it does play an influential role. Mortgage rates respond to several economic factors including inflation, the strength of the labor market and the Fed’s monetary policy, which is established by the Federal Open Market Committee.

“Going forward, it’s likely that mortgage rates will continue to fluctuate as the housing market continues to react to the uncertainty that permeates today’s economy,” says Jacob Channel, senior economist at loan marketplace LendingTree. 

To combat persistent inflation -- which was at 6% in February -- the Fed has hiked its benchmark short-term interest rate, the federal funds rate, eight times since last March. During its March meeting, Fed Chair Jerome Powell announced a 25-basis point (or 0.25%) rate hike. Wednesday’s meeting signaled that the Fed believes it’s starting to see progress when it comes to slowing down inflation, but it isn’t going to lift its foot from the gas pedal just yet.

What is the role of the Federal Reserve?

The Federal Reserve is the nation’s central bank. Consisting of 12 regional Federal Reserve banks and 24 branches, the Fed is run by a board of governors who are voting members of the FOMC. 

The FOMC is responsible for setting overall monetary policy, with the goal of stabilizing the economy and its growth. It does so, in part, by setting the federal funds rate -- the benchmark interest rate at which banks borrow and lend their money.

In an inflationary environment, like the one we’re in today, the Fed utilizes rate hikes to make borrowing money more cost prohibitive for both banks and consumers. Banks typically pass on the rate hike to consumers in the form of interest rates for longer-term loans, including mortgages. That has an impact on prospective homebuyers.

“Mortgage rates have pulled back about one-half percentage point since peaking above 7% in October,” says Greg McBride, chief financial analyst at Bankrate, CNET’s sister site. “But with mortgage rates still double where they were at the beginning of 2022, this does little to dent the affordability issues would-be homebuyers are facing.”

Factors that influence mortgage rates

Mortgage rates can vary from hour to hour and from person to person. What the Fed does matters but many other factors play a role in determining what mortgage rates are available to you.

“Mortgage rates won’t move in response to this rate hike, but will respond to changing expectations of inflation, interest rates and health of the economy,” says McBride.

Macro factors 

In addition to Fed policies, persistent inflation and the strength of the job market all point to mortgage rates near their highest levels in two decades, having surpassed 7% in October 2022.

Although the Fed raised the benchmark interest rate a quarter of a percentage point on Wednesday, it doesn’t mean that mortgage rates will rise in lockstep -- because the mortgage market may have already factored in the anticipated increase.

Micro factors 

But there are other factors that affect mortgage rates. When loan volume slows, lenders slash rates and loosen their credit requirements. Borrowers with a subpar credit score may actually have a better chance to qualify for a mortgage in a higher rate environment. 

When it comes to how a bank decides to make a loan, macroeconomic factors are only one part of the equation. There are a handful of much more specific factors that determine your particular mortgage interest rate. These include:

How the Fed’s decisions influence mortgage rates

Though the Fed doesn’t set mortgage rates directly, its decisions about the federal funds rate eventually affect mortgage rates and the broader housing market. “Generally, when the Fed raises the federal funds rate, that causes other rates in the economy, such as mortgage rates, to go up as well,” says Taylor Marr, deputy chief economist at Redfin, a real estate brokerage.

When the Fed makes borrowing more expensive, fewer people borrow. That tamps down demand for goods and services, including homes. And that’s why there’s a potential silver lining in a rate hike for some prospective home buyers.

Things to consider if you’re shopping for a mortgage

But higher mortgage rates will take a toll on many borrowers. “The increase in mortgage rates since the beginning of 2022 has been equivalent to more than a 32% increase in home prices -- and that’s on top of the already heady appreciation seen the past couple of years,” says McBride. 

Although it’s tempting to wait out higher mortgage rates with talk of a potential recession on the horizon, it’s risky to try to time the market and wait for mortgage rates or home prices to drop. Even if home prices depreciate and mortgage rates rise, as is expected, you could still end up with a higher monthly mortgage payment despite getting a good deal on your home.

“Instead of getting into the minutiae of what the market’s doing every six seconds, buyers need to focus on what it is they’re really trying to accomplish and have a good game plan,” says Jennifer Beeston, senior vice president at Guaranteed Rate, a national mortgage lender.

Regardless of what’s happening with the economy, the most important thing to consider when shopping for a mortgage is making sure that you can comfortably afford your monthly payments. Keeping your day-to-day financial life healthy is what matters the most when making a significant financial decision such as buying your first home. Make sure to always shop around and compare mortgage lenders to ensure you’re getting the best rates and terms available to you.

How rising interest rates affect your home equity

If you already own a home, mortgage rate fluctuations won’t affect you as much as borrowers applying for a new mortgage. But they can affect your home equity. What’s more significant for homeowners shopping for home equity loans and home equity lines of credit, or HELOCs, is the prime rate -- another baseline rate banks use for lending.

With mortgage rates close to 7%, a cash-out refinance won’t make financial sense for most homeowners who already locked in lower mortgage rates during the pandemic. In a rising interest rate environment, home equity loans and HELOCs can be a good option for financing. You can borrow against your home equity at a relatively low interest rate, and with a home equity loan, you can lock in a fixed interest rate so you don’t have to worry about the Fed’s next rate hike.

As a homeowner, keep in mind that although mortgage rates may not directly affect you, if you’re trying to sell your home, higher rates could limit the number of would-be homebuyers in your local market, McBride cautions.

The bottom line

When the Federal Reserve raises the benchmark interest rate, it indirectly pushes mortgage rates up. Mortgage rates have more than doubled since the beginning of 2022 and surpassed the 7% mark in October. Higher mortgage rates make buying a home more expensive. So if you’re shopping for a mortgage, make sure to compare the rates and terms being offered to you by banks and lenders. The more lenders you interview, the better your chances are of securing yourself a lower mortgage rate, especially in today’s rising interest rate environment.

First published on Sept. 20, 2022 at 12:48 p.m. PT.

Alix is a staff writer for CNET Money where she focuses on real estate, housing and the mortgage industry. She previously reported on retirement and investing for and was a staff writer at Time magazine. She has written for various publications, such as Fortune, InStyle and Travel + Leisure, and she also worked in social media and digital production at NBC Nightly News with Lester Holt and NY1. She graduated from the Craig Newmark Graduate School of Journalism at CUNY and Villanova University. When not checking Twitter, Alix likes to hike, play tennis and watch her neighbors' dogs. Now based out of Los Angeles, Alix doesn't miss the New York City subway one bit.
Katherine Watt is a CNET Money writer focusing on mortgages, home equity and banking. She previously wrote about personal finance for NextAdvisor. Based in New York, Katherine graduated summa cum laude from Colgate University with a bachelor's degree in English literature.