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How does the Fed affect mortgage rates?

The Federal Open Market Committee holds eight regularly scheduled meetings a year to discuss, strategize, and carry out the Federal Reserve’s two charters: to foster maximum employment and to maintain a stable rate of inflation. Today’s meeting focused on something called the federal funds rate. The concept of the federal funds rate is a simple one: it’s the rate at which banks borrow from each other. The Federal Reserve sets this rate, and all banks are required to honor it.fed

For the past 51 meetings, the FOMC has decided to keep the federal funds rate at or near 0%. Today the vote to continue to keep the rate at this level was unanimous (10-0). This decision did not surprise industry professionals, and the Fed even stated that they will likely keep the rate near zero percent in the next FOMC meeting coming up in April.

So how does this affect mortgage rates?

It works like this: banks are able to lend money inexpensively right now because of the federal funds rate. When banks get a good deal on borrowing money, they, in turn, don’t have to charge their borrowers as much. So when you go to a lender to borrow money for your mortgage, they will be able to offer you a lower rate than they would if they federal funds rate were higher. Ergo, mortgage rates are tied to the federal fund rate largely through banks’ lending behavior.

A general rule is that when the economy does well, mortgage rates rise. The Federal Reserve will raise the federal funds rate when they believe the economy is expanding at a healthy pace. As stated in Fed’s press release, the main concern right now is that, “recovery in the housing sector remains slow.” It’s likely, then, that the Fed kept the funds rate low to encourage more borrowing in the housing market.

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