What Does the Latest Fed Rate Hike Mean for Mortgage Rates?

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  • The Federal Reserve’s recent rate hikes won’t directly influence mortgage rates, but their effect on the economy could push them up or down.
  • Mortgage rates are more directly impacted by investor demand for mortgage-backed securities.
  • If the Fed can tame inflation, mortgage rates may trend down in the coming years. 

Inflation has Americans spending more in all areas of their budgets, including their mortgages.

Mortgage rates have increased over 2 percentage points so far in 2022. The average homebuyer getting a mortgage today is taking on a monthly mortgage payment that’s likely hundreds of dollars higher than what they’d be paying if they purchased when mortgage rates were at historic lows in 2021.

As inflation has grown, the Federal Reserve has been acting more aggressively to get it under control. The main way it does this is by increasing the federal funds rate, most recently by 0.75 percentage points in late July.

For homebuyers, hearing that the Fed is raising rates can be alarming. But while the Fed does often have some impact on whether mortgage rates go up or down, the central bank’s rate and mortgage rates aren’t as closely tied together as some might think.

The Fed is trying to get inflation under control

The federal funds rate is a tool that the Fed uses to influence inflation. In June, inflation reached a 41-year high. Inflation that gets too high is bad for the economy, so the Fed raises rates to increase the cost of borrowing and slow economic growth. 

“The Fed needs to cool inflation, and getting loan products to cost more slows down spending,” says Shashank Shekhar, founder and CEO of InstaMortgage. “So an abrupt spike is the Fed’s way of saying ‘Okay, we need to slow down before we can speed things back up.'”

What the Fed rate hike means for mortgage rates

When the federal funds rate goes up, short-term consumer rates typically trend up, too. This includes things like credit cards and auto loans.

But the Fed’s impact on mortgage rates is less direct, and has to do more with the economic conditions it’s addressing. In the days leading up to the Fed’s July meeting, mortgage rates actually trended down, even though most investors were expecting another 75-basis-point, or 0.75-percentage-point, hike.

Investor expectations around Fed policy can push mortgage rates up or down

After a consumer closes on a mortgage, it’s sold and packaged into a type of bond called a mortgage-backed security (MBS). Investors who buy MBSs watch the Fed’s actions closely and try to predict how those actions might impact the economy, which in turn impacts their investments.

Right now, inflation is high, eroding the returns on their investments. Because of this, lenders have to raise rates to make their mortgages more attractive to investors. So if investors believe that the Fed won’t be able to tame inflation, mortgage rates might trend up.

If the Fed’s recent rate hikes are successful in cooling the economy, mortgage rates may remain at their current levels or come down slightly. But if the central bank is unsuccessful, the cost of getting a mortgage could continue to rise, along with other goods and services. If the economy cools too much and we enter a recession, rates could drop.

In its July forecast, the Mortgage Bankers Association predicted that 30-year fixed mortgage rates would remain above 5% for the rest of 2022, but that they’d start to slowly come down and reach 4.8% by the end of 2023.

What does the Fed rate hike mean for homebuyers and sellers?

As mortgage rates have risen, more would-be homebuyers have been pushed out of the market due to a lack of affordability. This has reduced buyer demand and slowed the housing market somewhat.

“The fewer homes being purchased today will finally open up some much needed inventory and lower home prices in key markets so people can buy,” Shekhar says. “And people will buy, even at a higher rate, if the price is right, because they know they can refinance to a better rate when the Fed begins to lower interest rates again once inflation is back under control.”

If you’re ready to start the homebuying process, you shouldn’t necessarily let the current economic conditions stop you. Rates are high, but if you’re willing to reevaluate your budget to account for that, you may still be able to find a home that suits your needs.

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