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Jun 14

How the Fed Impacts Mortgage Rates

The Federal Reserve Open Market Committe (FOMC) meets at least eight times per year to discuss and vote on US monetary policy.  The Fed controls the Fed Funds rate, which is essentially a bank’s cost of money.  When the Fed increases the Fed Funds rate, short-term interest rates such as the Prime rate and LIBOR go up.  These are often used to determine interest rates on adjustable rate mortgages, home equity lines of credit, credit card balances, and business loans.

However, interest rates on fixed-rate mortgages are not tied to changes in the Fed Funds rate.  Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market. When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other “securitizers”. These “securitizers” get their money by issuing bonds to bond market investors.  These bonds are called “mortgage bonds” or “mortgage backed securities”.  Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market.  As you can see from the chart, the Fed owned zero ($0) mortgage bonds prior to 2008. Once the financial crisis happened, the Fed decided to start buying mortgage bonds in order to drive interest rates down and stimulate the economy. Currently, the Fed owns a whopping $1.75 TRILLION in mortgage bonds!

In fact, the Fed has been the biggest buyer of mortgage bonds in recent years. However, the Fed has indicated that at some point, they will slow down or stop their purchase of mortgage bonds. At the moment, the market is thinking this will happen sometime toward the end of 2017 or beginning of 2018. Market expectations can change at any time though. That’s why it’s not cut and dry how mortgage rates will react as the Fed changes (or doesn’t change) the Fed Funds Rate. Please contact me for further details or for a real-time analysis of where mortgage bonds are headed.