4 minute read
The Federal Reserve and Mortgage Rates What Realtors Need to Know
BY RYAN PAQUIN
The economic rollercoaster since the COVID-19 pandemic has reshaped the financial landscape, leaving its mark on inflation, interest rates, and housing markets.
In response to soaring inflation triggered by the economy’s reopening, the Federal Reserve (the Fed) raised the Fed Funds Rate from a near-zero range in early 2022 to 5.25%-5.50% by mid-2023. Conventional 30-year fixed mortgage rates followed suit, climbing from an average of 3.50% to a staggering 7.80% in October 2023.
Although the Fed began reducing rates in late 2024, average mortgage rates have remained stubbornly high—a puzzling outcome for many. For Maryland’s REALTORS®, understanding the Fed’s influence on mortgage rates is crucial for advising clients and navigating market changes.
The Role of the Federal Reserve
The Federal Reserve is the central bank of the United States, tasked with two primary goals:
Maximizing Employment
Stabilizing Consumer Prices (Inflation)
Additionally, the Fed oversees bank regulation, financial research, and other critical tasks that shape the economy. It operates through a system of twelve regional banks and a Board of Governors, which collectively monitors economic conditions and sets monetary policy.
One of the Fed’s most powerful tools is the Fed Funds Rate, the interest rate banks charge one another for overnight loans of reserve balances. While technical, this rate indirectly impacts consumer financial products, including mortgage rates, through its influence on lending, borrowing, and investment behaviors.
How the Fed Funds Rate Affects Mortgage Rates
Banks play a significant role in the mortgage market as major purchasers of mortgage-backed securities (MBS). These securities pool mortgages into investments that banks buy to earn returns. For banks, the Fed Funds Rate is a baseline cost of borrowing. They aim to earn a profit by maintaining a spread between their borrowing costs and the returns on assets, like mortgages.
One frequently used government bond benchmark to which mortgage lenders often peg their interest rates is the 10-year Treasury bond yield. Typically, MBS sellers must offer higher yields because repayment is not 100% guaranteed as it is with government bonds.
The Role of Market Expectations
The Fed’s influence extends far beyond short-term bank borrowing costs. Investors closely follow Fed policies because they shape expectations about future interest rates. These expectations drive how much investors are willing to pay for mortgage assets today. For example:
If investors believe rates will decline, they’ll pay a premium for mortgages with higher current yields. This pushes mortgage rates down.
Conversely, if investors anticipate rising rates, they’ll require a discount, leading to higher mortgage rates.
Since mortgages are long-term assets, investors focus more on future rate projections than on today’s rates.
Why Mortgage Rates Didn’t Drop in Late 2024
When the Fed cut the Fed Funds Rate by 0.50% in September 2024, many expected mortgage rates to decline. However, the bond market had already priced in this rate cut based on earlier signals from the Fed. Mortgage rates, instead, responded to Fed Chair Jerome Powell’s comments about future policy.
Powell’s cautious tone about further cuts led investors to revise their long-term rate expectations, resulting in higher mortgage rates despite the short-term Fed Funds Rate reduction.
This phenomenon underscores a key point: the mortgage market doesn’t react solely to the Fed’s immediate actions but to how those actions influence the outlook for long-term rates.
What REALTORS® Should Take Away
The Federal Reserve wields immense influence over the mortgage market, but its impact isn’t always immediate or straightforward. REALTORS® should keep the following in mind:
Fed Actions Set the Tone
The Fed’s policies provide a framework for where rates may go, but markets adjust based on future expectations.
Market Sentiment Matters
Investors react to what they think will happen next. The Fed’s statements and economic data can influence mortgage rates as much as, or more than, its rate decisions.
Stay Informed
Understanding how monetary policy influences rates can help REALTORS® guide clients and anticipate market trends.
For REALTORS®, staying attuned to the Fed’s actions and their broader implications can be a valuable tool in navigating a challenging market. By understanding the intricate dance between Fed policy and mortgage rates, you can provide informed advice to buyers, sellers, and investors in the Maryland housing market.
Ryan Paquin is a dedicated mortgage consultant and Branch Manager at First Home Mortgage in Crofton, Maryland. He has assisted over 4,000 families in home financing.
