The Federal Reserve is widely expected to raise interest rates in December, for the first time in nearly a decade. This Bankrate article from Katherine Reynolds Lewis takes a look at how rate fluctuations can affect mortgage rates – and other parts of our financial lives.
“The Federal Reserve has its fingers in your pocketbook to a greater degree than the IRS,” says Michael Reese, a CFP professional in Traverse City, Michigan.
The interest rates you pay and earn, the availability of credit and even your prospects in the job market are linked to the projections and judgments of Federal Reserve Board Chair Janet Yellen and the other members of the policymaking Federal Open Market Committee, made up of Fed board governors and reserve bank presidents.
They meet in Washington to set monetary policy, primarily by raising or lowering the Fed’s target for what’s called the federal funds rate.
The Fed’s mission is to foster economic growth without raising inflation. “The Fed has a dual mandate. They want to have low and steady inflation and a strong labor market,” says Gus Faucher, senior macroeconomist with The PNC Financial Services Group.
When the Fed lowers the federal funds rate, lenders can finance home loans more cheaply. As a result, they can reduce the interest rates they charge for a fixed-rate mortgage.
In recent years, the federal funds rate has been near 0%, as the Fed has attempted to stimulate the housing market.
“The Fed is making homes affordable at all-time levels with low interest rates on mortgages,” Mervine says. “A lot of people are underwater, but if they can save and pay down their prior mortgage, they can refinance at extremely low rates.”
The Fed can even control the shape of the yield curve, or the relation between interest charged for 1-year loans, 3-year loans, 5-year loans and so on. “If they want to bring down 10-year rates, they’ll go out and buy 10-year securities,” says Oghoorian.
Mortgages are pegged to the 10-year Treasury rate, because refinancings and early payoffs effectively give a 30-year mortgage a 10-year lifespan, Oghoorian says. Competition and market conditions also affect rates.
The Fed’s actions also influence the availability of credit. When the Fed is boosting the money supply – for instance, by buying government bonds from the market – lenders are more willing to extend credit.
At the 8 regularly scheduled FOMC meetings a year, committee members decide how many securities to buy and at which maturities, after they pore over data and reports from across the country on the labor market, inflation and economic growth.
The committee then unveils its new target range for the federal funds rate, currently a record-low 0%-0.25%, and shares its members’ economic projections in an announcement closely watched by traders and policymakers around the world. Within seconds, financial markets begin to adjust, affecting your pocketbook in numerous ways.
The Fed’s actions indirectly have an impact on the prices you pay at the grocery store, gas pump and other retail outlets.
That’s because the cost and availability of money affect people’s willingness to pay for goods and services. When money is cheap and plentiful, there’s more demand and prices tend to rise.
