Yesterday the Fed increased the target funds rate .25%. This was the 4th time the Fed has raised rates since December 2015 when it was decided the economy was stable enough to begin increasing rates after a period of recession and a long-running Fed funds rate of .25 (effectively 0% as this is the lowest rate possible). With ‘rate increases’ in the news so frequently many people panic, thinking the home or auto loan they’re about to get is about to get more expensive. Real estate agents often tell buyers to “move quickly before the Fed increases rates!”, and some mortgage lenders even use the Fed movements as a marketing opportunity. In reality, though, the Fed rates don’t have much effect on your home loan rates at all, at least initially.
What is the Fed Rate?
The Fed Funds rate is the rate at which banks borrow money to either lend or meet reserve requirements, not what consumers pay for loans. So if you could get a 4% yesterday on your mortgage, the rate isn’t going to change to 4.25% today because of the Fed move. Likewise your auto loan rates won’t be any different today, either. The Fed funds rate is more impactful to financial institutions than it is to consumers, at least short term.
What does change with the Fed Funds rate?
Variable rate debt often changes along with the Fed funds rate. Credit card rates? They’re influenced since the Prime rate is linked to the Fed funds rate, so your credit debt or home equity line of credit is likely about to get more expensive than it was yesterday morning. Variable rates on things like student or business loans can also adjust along with the fed funds rate, so these are areas that could see an increased interest rate as a direct result of Fed action.
Immediate VS Long term impacts
The immediate impact of Fed rate adjustments can act opposite of what most think makes sense. For example, the day the Fed raises their fund rate, mortgage rates often see improvements – this was the case yesterday, as the Fed raised rates and mortgage rates saw one of their largest drops of the year (and reached their best level of the year). Consumers (with the exception of those carrying the types of debt mentioned above with large balances) generally feel very little immediate impact from Fed rate changes. Businesses and banks can feel some immediate impact though, and often times this benefits mortgage bonds at the expense of stock losses. Typically, Fed movements are baked into the markets over a period of time, so unless there’s a surprise on Fed announcement days, stocks and bonds generally don’t see a ton of movement.
Long term, Fed rate increases are done in economically improving environments to combat inflation (or the potential for it). Since inflation is the arch enemy of long term investments like mortgage bonds, when it does rear it’s head, inflation can cause mortgage rates to rise, however the direct cause is inflation, not a Fed move. In economically improving times, stocks generally benefit as well, sucking money from safer but lower yielding investments like long term mortgage bonds and treasuries. For this reason, mortgage rates can also increase in times when the Fed is raising their rates, but the movements are in correlation, not a result of causation. But Fed movements can also decrease mortgage rates – along with the announcement of increasing, decreasing, or leaving alone the Fed funds rate, the Fed issues a statement. If that statement is a negative economic outlook, we often see mortgage rates improve. In fact, when the Fed began raising their Funds rate in 2015, the economic outlooks that went along with those increases were so conservative, mortgage rates bottomed out for a long period of time.
Things to remember
- The Fed doesn’t directly affect mortgage rates
- Both the direction of the funds rate AND the Fed statement is an indicator on where rates may be heading
- Variable rates, especially those linked to the Prime rate, will rise and fall with Fed movements
- Avoid scare tactics and dismiss anyone saying that Fed movements will have a negative impact on their home loan rates
- Economic movements and day to day world events have more impact on short term mortgage rates than Fed changes