Mortgage rates and the Fed: a primer
If you’ve been thinking of buying a home or investing in real estate—but are waiting to see what the Fed is going to do—you’re not alone. After all, the Federal Reserve rate is in the news almost every day. Just last week the rate dropped a quarter of a point. Mortgage rates should follow, right?
Is now the time to pull the trigger, or should you wait for the next cut?
To answer that question, we need to know a little bit about the three most important interest rates in our complex economy. Spoiler alert: interest rates usually move together, but not always. Sometimes when the Fed Funds rate drops, mortgage rates even rise!
- The Fed Funds rate is the one the news is always chattering about. It’s determined by the Federal Reserve and is the basis for all other short-term rates, like the amount the bank pays on your savings account.
- The prime rate is the one set by the banks. It determines most borrowing costs – everything from your auto loan to credit cards to your home equity line of credit. It generally moves in lockstep with the Fed Funds rate.
- Mortgage rates are different. They are mainly determined by long-term Treasury bonds which are not controlled by the Fed. These Treasury bonds typically have 10-year terms and are priced based on the market’s assessment of the economy. When the economy is doing well, investors tend to pull out of the Treasury bonds to earn a better return elsewhere. This tends to push up long-term rates. When the economy is doing poorly, investors will often wait out the storm in Treasuries, which are safer.
Mortgage rates will generally follow these longer term Treasury rates, up and down. However it isn’t always a one-to-one relationship. Sometimes Treasury rates will fall, and mortgage rates will go nowhere. This is because mortgage rates are also determined by mortgage-backed securities which have different characteristics than Treasury bonds.
If your head is spinning by now, welcome to the club. Mortgage-backed securities are complex. Wall Street firms have spent tens of millions on supercomputers to model their movement. They are fiendishly difficult to predict.
The takeaway is that mortgage rates generally move in the same direction as the Fed Funds rate, but it isn’t an exact relationship. The latest drop in mortgage rates, bringing us to the lowest rates in two years, actually preceded the Fed Funds rate cut by months.
So what’s the answer – is now the time to buy or not?
The time to buy for homebuyers is when you need the home; for investors it’s when you are ready to invest. Residential real estate is traditionally a good investment no matter what the rates are. Just make sure you get a payment you are comfortable with, and the ability to refinance when and if rates come down.