Impact of Federal Reserve on Home Loans: Exploration of the Connection
Fed Rate Pause and its Impact on Mortgage Rates
The U.S. Federal Reserve's decisions on borrowing costs can have a significant effect on adjustable-rate mortgage (ARM) rates and, to a lesser extent, fixed-rate mortgages.
When the Fed pauses its rate decisions, adjustable-rate mortgage (ARM) reset rates typically remain stable since ARMs are tied to short-term benchmarks closely linked to the Fed's policy rate. However, fixed-rate mortgage rates do not move directly or immediately with the Fed’s rate decisions because they are more heavily influenced by longer-term bond yields, especially the 10-year Treasury yield.
The cost for banks to borrow, as dictated by the federal funds rate, influences the cost for consumers to borrow, including mortgage rates. When the Fed pauses rates, fixed mortgage rates tend to remain relatively steady but can fluctuate based on how investors view inflation, economic outlook, and Treasury yields. If investors expect inflation to remain high or the economy to strengthen, 10-year yields may rise, pushing fixed mortgage rates higher despite the Fed pause.
In contrast, adjustable-rate mortgages (ARMs) are more directly impacted because their rates reset based on short-term interest rate benchmarks that closely follow the federal funds rate. A Fed rate pause often leads to stable ARM rates since the underlying short-term rates linked to Fed decisions remain steady.
| Mortgage Type | Impact of Fed Rate Pause | Linkage | |-----------------------|-------------------------------------------------|-------------------------------| | Fixed-rate mortgage | Rates generally hover as 10-year Treasury yields drive pricing; may fluctuate with economic outlook and inflation | Influenced by 10-year Treasury yield (long-term market) | | Adjustable-rate mortgage (ARM) | ARM reset rates stabilize as Fed short-term rates remain unchanged | Directly linked to Fed federal funds rate (short-term benchmark) |
The Fed's decisions can influence the percentages lenders offer to would-be homeowners. For instance, in response to the economic effects of COVID-19, the Fed cut the federal funds rate to near zero in 2020, leading to historic lows in 30-year mortgage rates. In contrast, though the Fed cut its rate three times at the end of 2024, mortgage rates remained elevated, often averaging above 7 percent.
Starting from March 2022, the Fed raised their rate consistently, with the federal funds rate reaching 5.33 percent in August 2023 and staying there until the end of September 2024. As the funds rate grew, so did mortgage rates, with the 30-year rate breaching 8 percent in October 2023.
Mortgage rates can also be influenced by factors such as inflation, supply and demand, and the secondary mortgage market. When comparing rates, it's important to consider the APR, not just the interest rate, as some lenders may offset low interest rates with high fees. Knowing your APR will help you understand your true, all-in cost when getting a mortgage.
The Federal Open Market Committee (FOMC) will meet next on September 16 and 17, when they will release their next summary of economic projections.
The Fed's pause on rate decisions can result in relatively stable adjustable-rate mortgage (ARM) rates due to their linkage to short-term benchmarks closely tied to the Fed's policy rate. Conversely, changes in the Fed's decisions can influence the cost for banks to borrow, which can further impact the interest rates offered by lenders for business financing, including mortgages.
