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How the Federal Reserve rate decision affects mortgage rates
The Federal Reserve, or “the Fed,” is the central bank of the U.S. and plays an outsized role in shaping the nation’s monetary policy. One of its key functions is setting interest rates. Those rates determine how much Americans earn on their savings and how much they pay to borrow — including when buying a home.
Now, the Fed doesn’t say, “Here are the mortgage rates for buying and refinancing homes.” Instead, it sets what’s called the federal funds rate, and that rate impacts a wide variety of financial products. As a result, when the fed funds rate rises and falls, so do the rates Americans pay for mortgage products. Sound confusing? Don’t worry. We’re here to break it down so you can make your next buying or refinancing decision more confidently.
Read more: How are mortgage rates determined? It’s complicated.
In this article:
What does the Federal Reserve do?
To understand how the Federal Reserve works, think of the U.S. economy as a farm and the Fed as a farmer in charge of water, representing money and credit. “Our farmer wants enough water flowing into the farm so that the crops grow. Think of that like job creation and economic growth,” said Corbin Grillo, a certified financial analyst with Linscomb Wealth, via email. If the farmer (the Fed) leaves the faucet on full blast, the crops will flood, causing inflation. If the farmer doesn’t water the crops enough, they’ll wither, causing a recession.
The Fed’s job is to continuously make decisions that keep the right amount of water (money and credit) flowing so that its crops (the U.S. economy) grow and thrive.
The federal funds rate
To control the flow of water (money and credit), the Fed sets the federal funds rate, a benchmark interest rate that affects multiple parts of the economy. Consumers can see the impacts of the fed funds rate on products, ranging from savings accounts to mortgage rates. And although the federal funds rate doesn’t affect mortgage interest rates as directly as savings or personal loan rates, it does have an influence. (More on that later.)
If the economy is dry — that is, if people aren’t spending money — the Fed adds more water by lowering the fed fund rate to encourage people to spend. Low interest rates make it less expensive to borrow money, so people tend to spend more freely and use credit to make larger purchases. However, if the economy starts to flood because people are spending too much, the Fed dials back the water to keep the crops (economy) alive by increasing the fed funds rate. Higher interest rates encourage people to save instead of spend because borrowing money is expensive.
While the federal funds rate had been at a 23-year high since July 2023, the Fed finally lowered the rate at its meetings in September and November 2024. It's possible the central bank will cut the rate again in December, but that decision is by no means set in stone — especially as the Fed waits to see how Trump's victory in the presidential election will impact the economy in the coming weeks.
Dig deeper: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards
Fed rates and mortgage rates
Remember how we said that the Fed doesn’t directly set mortgage rates? It’s true. However, the fed funds rate impacts the yield on the 10-year Treasury note, which directly affects what consumers pay when they borrow money, said Kevin Khang, senior international economist with Vanguard, in a phone interview.
“[The] 10-year rate, the yield on that note, is kind of like the absolute minimum people should expect to pay when they borrow,” Khang said. “It serves as a benchmark, and everyone else should expect to pay a little more.” Why more? The middlemen. “Lenders have to get compensated for taking on the credit risk for homeowners.”
So, let’s look at how the 10-year Treasury and mortgage rates have moved together in the past few years. In May 2020, the fed fund rate dropped to 0.05%, and the 10-year Treasury yield was roughly 0.64%. The average rate on a 30-year fixed-rate mortgage at the time was 3.28%. Flash forward to today (and buckle up).
Inflation meant that the Fed needed to dial back the water, so it raised the federal funds rate. As of November 2024, the fed funds effective rate was 5%, and the 10-year Treasury was 4.26%. The average 30-year fixed mortgage rate was then 6.79%.
As you can see, 10-year Treasury yields and mortgage rates also tend to increase when the federal fund rate increases. However, the inverse is also true.
Learn more: How inflation impacts mortgage rates
Do mortgage rates go down when the Fed cuts rates?
Usually, the simple answer is yes — mortgage rates tend to go down when the Fed cuts interest rates.
However, right now, the answer is: It depends. There's a lot going on in the U.S. economy that impacts mortgage rates other than the Fed rate. Investors' projections about what Trump will do in office is affecting the 10-year Treasury yield, and Trump and the Federal Reserve have a complicated relationship. A lot is up in the air right now about how future Fed rate cuts will impact mortgage interest rates.
Dig deeper: When will mortgage rates go down? A look at 2024 and 2025.
Fed rates and mortgage rates: Tips for borrowers
Now that you understand the connection between Fed rates and mortgage rates, what should you do with this information? Here are some ideas to consider as you look to purchase or refinance a home in today’s economy.
Control what you can
“We generally wouldn’t recommend consumers spend much time worrying about things that are out of their control,” said Grillo. Since you have no impact on the federal funds rate or the 10-year Treasury yield, it’s better to focus on things in the mortgage process under your control.
Comparing mortgage lenders, interest rates, and closing costs can help you find the best possible product for your credit score, market, and financial situation.
Read more: The best mortgage lenders right now
Consider an adjustable-rate mortgage
Over the past few years, adjustable-rate mortgages have fallen out of favor as interest rates climbed. Now, these mortgages could help first-time buyers and those refinancing ride an anticipated wave of declining interest rates. Popular mortgages for first-time buyers, like VA and FHA loans, offer adjustable-rate products.
While there’s no guarantee that mortgage rates will decrease, it could be the ideal time to consider an adjustable-rate loan. A conversation with a mortgage professional can help you understand your options.
When a fixed-rate loan might be better
If you value consistency and predictability, you may be better off with a fixed-rate mortgage if rates trend downward. But with the Fed's recent decision to cut rates — a trend that could continue through 2025 — how long should you wait before locking in a mortgage rate? Khang said the decision is a personal one and depends on your needs and finances. If you need to move, you may take today’s best rate and hope to refinance into a lower rate later.
Others may have more flexibility. Khang said that those who don’t need to buy now may want to hold out for at least a year now that the Fed has started cutting rates. “Financiers can take some time to adjust their spread [between the 10-year Treasury and mortgage rates],” Khang said. “So, it can take some time for lenders to catch up with lower rates.”
Read more: How a float-down option lowers your locked-in mortgage rate
The Federal Reserve and mortgage rates: FAQs
What role does the Federal Reserve play in the real estate mortgage industry?
The Federal Reserve sets the federal funds rate. That rate influences the yield on the 10-year Treasury note, which serves as the index for most mortgage rates in the U.S. As the fed funds rate increases and decreases, so does the yield on the 10-year Treasury; mortgage rates tend to follow the same trends.
Will my mortgage go down if interest rates drop?
If interest rates drop, your mortgage payment may go down if you have an adjustable-rate mortgage. However, if your current mortgage is a fixed-rate product, your interest rate remains the same for the life of your loan unless you refinance to a loan with a lower rate.
Who controls the housing interest rate?
The Federal Reserve tends to have the most control over housing interest rates in the U.S. It sets the federal funds rate, which influences rates on various products, including government securities, savings accounts, and loans. As the fed funds rate rises and falls, so do mortgage rates.
This article was edited by Laura Grace Tarpley.
