The Fed’s Effect on the Mortgage Market

By Steven Milstein and John Flouskakos

If you’re in the market to purchase a home or another type of real property, you likely know that mortgage rates have been on the rise. One of the driving factors in the rise in mortgage rates is the recent actions of the Federal Reserve (the “Fed”). The Fed is the central banking system of the United States of America. It is responsible for “managing U.S. monetary policy, regulating bank holding companies and other member banks, and monitoring systemic risk in the financial system.”[1] Although the Fed does not directly control mortgage rates, its ability to set the federal funds rate creates a ripple effect on the entire mortgage market.

Banks are required to maintain a certain cash reserve sufficient to cover their clients’ withdrawals and other obligations. If a bank’s cash reserve falls below its required threshold, that bank will need to borrow money from another bank (one that has money in excess of their own reserve requirement) in order to satisfy their reserve requirement. Like any other loan, these interbank loans will bear interest at a rate within the range set forth by the federal funds rate. The federal funds rate acts as a guide for banks and other institutions in setting the interest rate for these interbank loans. The Fed is the institution that sets, and can change, the federal funds rate. So far, in 2022, the Fed has hiked the federal funds rate four (4) times![2] Banks will in turn, charge interest to their own customers, largely based on how much interest the bank needs to pay on the loans they take out to cover their required cash reserves. In other words, the more money it costs a bank to lend to you, the more the bank is going to charge you to borrower those some funds.

One of the reasons the Fed raises the funds rate is to try and curb inflation. When the Fed starts to see inflationary trends (for example, too much money in circulation), it raises the funds rates, which in turn forces the banks to raise their interest rates, which reduces the amount of money people borrow (because who wants – or can afford – to pay an incredibly high interest rate?!). In turn, a reduction in borrowing reduces the amount of money in circulation, which helps curb inflation.  

Just like consumer interest rates, the increase in the funds rates will affect the mortgage rates and the housing market. As the funds rates increase, the mortgage rates will follow. This affects the housing market as fears of rising mortgage rates oftentimes quell the housing market – history has proven that predictability and stability are far more appealing to homeowners than volatility.

There is, however, a silver lining to all this – mortgage rates are often forward looking. Recent trends have shown that fixed mortgage rates have already accounted for further increases in the federal funds rate. Therefore, fixed mortgage rates are likely to remain more stable even if the Fed chooses to hike up rates again.

For more information, or for help on your mortgage or loan, reach out to the knowledgeable real estate attorneys at KI Legal.

[1] James McBride and Anshu Siripurapu, What is the U.S. Federal Reserve, Council on Foreign Relations (Jan. 27, 2022), https://www.cfr.org/backgrounder/what-us-federal-reserve.

[2] David Gura, Another Big Fed Rate Hike is Here to Battle Inflation. Economy Hangs in Balance. NPR (2022), https://www.npr.org/2022/07/27/1113494056/fed-interest-rate-hike-julymeeting#:~:text=Economy%20hangs%20in%20balance%20U.S.,t%20seen%20since%20the%201980s. (last visited Aug 12, 2022).

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