Does the Fed set mortgage rates?

A young family looking at a home with their real estate agent, as they consider if the Federal Reserve sets mortgage rates.Image: A young family looking at a home with their real estate agent, as they consider if the Federal Reserve sets mortgage rates.
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The Federal Reserve can help influence mortgage rates. But your individual financial situation also plays a big role in the rate you can get for a home loan.

When you buy a home, the Fed’s monetary policy is one of many factors that influences your mortgage rate.

While you can’t control what the Fed does, you can help set yourself up to get a competitive mortgage rate by demonstrating a positive credit history, paying off debt and saving up for a down payment.



Does the Fed set mortgage rates?

Not exactly.

The Federal Reserve doesn’t mandate the price that banks charge homebuyers to lend money. As private businesses, banks are allowed to set their own rates.

But the Fed’s monetary policies can still influence the mortgage rates that lenders set. This could impact the interest rates you pay for a new home loan, a refinance of your current home loan, or a home equity loan or home equity line of credit (aka HELOC).

Let’s take a closer look at how the Fed influences mortgage rates from afar.

How does the Fed influence mortgage rates?

The Fed is responsible for setting the federal funds rate, which can affect the interest rates and, in turn, the monthly payments, for everything from mortgage loans to credit cards and auto loans.

What is the federal funds rate?

The federal funds rate is the amount banks charge to lend each other money. Here’s how it works.

There’s a federal requirement known as Regulation D that says banks must keep a certain amount of reserves on hand at any given time. This rule protects banks from running out of money if too many customers try to withdraw funds at the same time.

When a bank doesn’t have enough money in reserves, it borrows from another bank. The interest rate the bank pays to borrow that money is what’s known as the federal funds rate.

What is the prime rate?

Along with determining the rate at which banks borrow from each other, the federal funds rate also affects the prime rate. The prime rate is the base rate that banks charge borrowers to lend money for everything from mortgages to credit cards and auto loans.

When you buy a home, the bank looks at different factors like your credit history and the length of your mortgage to set your mortgage rate. But if you look at the fine print, you might notice the prime rate is added on top of the other interest charges you pay.

The prime rate is usually a little higher than the federal funds rate, because it wouldn’t make sense for banks to lend money for less than they pay to borrow it.

So when the Fed raises interest rates on banks, the prime rate usually goes up — and when the Fed lowers rates, banks tend to follow suit to stay competitive.

Now that you know more about how the Fed affects mortgage rates, you might be wondering about all the other factors that can go into determining your rate.

What other factors influence mortgage rates?

As you can see, the Fed only plays an indirect role in setting your mortgage rate.

Let’s take a look at some of the other factors that influence mortgage rates. This will help you figure out what you can work on as a borrower to get a great mortgage rate, and what things are simply out of your control.

Your financial situation

Mortgage lenders are more likely to give you better terms if you have strong credit.

Banks look at your credit history to get an idea of how likely you are to repay the money you borrow. So having better credit means you’re more likely to be approved for a lower mortgage rate.

Lenders also compare your income to your debt to make sure you have enough money left over to cover your monthly mortgage payment.

They also want to see that you have enough emergency savings.

The property you’re buying

 Generally, mortgage lenders look at …

  • The home price and loan amount
  • The down payment amount
  • The length of the mortgage
  • The type of interest rate, such as a fixed-rate or adjustable-rate
  • The type of mortgage, or loan type — for example, conventional loans, FHA loans, VA loans from the Department of Veterans Affairs, USDA loans or jumbo loans

If you’re looking for more-competitive rates, you might also be able to get a lower interest rate and annual percentage rate, or APR, by purchasing mortgage points.

Mortgage points, also known as discount points, give you the option to pay a fee up front to lower your rate. This could help you save money on interest charges in the long run.

The economy and financial markets

The economy and financial markets can also influence mortgage interest rates for buyers.

When you buy a home, you have absolutely no control over economic conditions like inflation or other factors that affect interest rates.

You could also find yourself at the whims of the financial market and the housing market, since 10-year Treasury bond yields, home sales and housing starts (new construction) affect mortgage rates. While you might have some control over the type of home you buy and your finances, the direction of these market forces are completely out of your hands.


What’s next?

If you’re thinking about buying a home and looking for the best deal, it’s important to focus on the things you can control.

The Fed’s decisions and other market conditions may be out of your hands, but whatever the current mortgage rates are, if you focus on building credit, getting out of debt, and saving for a down payment, you can position yourself to qualify for better mortgage loan rates. While you’re at it, you can use Credit Karma’s mortgage calculator to figure out how much home you can afford, and then compare rates on our website to help you find the best mortgage lender for your situation.


About the author: Tim Devaney is a personal finance writer and credit card expert at Credit Karma. He’s a longtime journalist who prides himself on being a good storyteller who can explain complex information in an easily digestible wa… Read more.