If you keep up with financial markets, you’ve most likely seen that the Federal Reserve has started what is likely to be a series of interest rate hikes. But even if you’re not a finance news junkie, this move can still impact your life, especially if you plan to purchase or refinance a home in the near future. But what exactly does a Fed rate hike do and how does it affect mortgage prices? We’ve got the answers you need.
What is the federal funds rate?
The federal funds rate refers to the interest rate at which banks and credit unions lend to each other overnight to maintain their reserve requirements as dictated by the Federal Reserve. Financial institutions with surplus reserve balances lend money to those who need extra funds to meet their reserve balance requirement overnight. Banks generally negotiate this interest rate, which is called the federal funds effective rate. This number is influenced by the federal funds target rate, which is set by the Federal Open Market Committee, or the FOMC. The FOMC is comprised of the Federal Reserve chair, the board of governors, and a rotation of Federal Reserve Bank presidents from across the country.
How does the fed funds rate affect mortgage rates?
Clearly, neither the fed funds target rate or effective rate is tied directly to mortgage interest rates. But just like most things in our economy, all of these rates are inextricably combined. Any additional expenses incurred by financial institutions are passed onto customers in some form or fashion. If banks must spend more to borrow money for their reserve balances, interest rates will go up across the board. This includes business loans, car loans, private student loans, and of course, mortgages.
If you currently have a mortgage with a fixed interest rate and are happy with the payments and loan structure, then rate hikes won’t affect you. But if you’re considering a new real estate purchase or a refinance, then you can expect to see mortgage rates begin to creep up because of the federal funds rate. Similarly, if your ARM is about to reset, you can likely expect an increase in your rate. This might be a good time to refinance into a fixed rate or an ARM with a new fixed rate period.
What can we expect from the Federal Reserve throughout 2017?
In this year’s March FOMC meeting, the Committee voted to increase the fed funds rate by a quarter of a percent. This decision followed a similar increase in December 2016, indicating a continued upward trend at future meetings. Then in May’s FOMC Meeting they voted to maintain the current rate. There’s no way to know exactly what to expect at the year’s remaining meetings, but more rate hikes are expected as the economy continues to grow. Many financial experts predict two more increases in 2017. Charles Evans, president of the Federal Reserve Bank of Chicago, recently said there could be anywhere from two to four total increases in 2017, depending on the economy and inflation.
To provide you with further information on how the Fed rate affects mortgage prices, we’ve highlighted some data that you should know to be enlightened on its financial impact.
1. The Fed Impacts Prices
The reason behind this is the fact that the cost and availability of funds affect the behaviour of people when it comes to the purchase of goods and services. Basically, with its desire to fight inflation, federal funds rate is raised.
2. The Fed Impacts Jobs and Wages
Though indirectly, the Fed also affects the job market because when federal funds rate is increased, the economy tends to slow down leading to lower employment rate. In order to fight inflation, the power to demand for wage increase is also lower.
3. The Fed Indirectly Influences Mortgages
As mortgage rates respond to market forces, the Feds also indirectly influences mortgages. Meaning, there is a tendency for mortgage rates to go up when the Fed increases short-term rates. At the same time, there is also a tendency for mortgage rates to fall after the Fed increases the federal funds rate.
There’s obviously no crystal ball method to figuring out the exact trajectory of the fed funds rate or mortgage rates. But one thing is clear: change is on the horizon, even if we don’t know how fast. This makes now a good time to start evaluating your upcoming real estate needs so you can lock in the lowest rates possible.