Mortgage Insights: Mortgage Rates Vs. The Fed Funds Rate
The media tends to hyper-focus on the federal funds rate and they love to speculate how this will affect mortgage rates and the housing market. For certain homebuyers this constant speculative chatter can be a major distraction. So, it is very important to understand that mortgage rates and the fed funds rate are not directly linked on a one-for-one basis. And, at times, they can even move in opposite directions.
Broadly speaking, the main differences between these two rates are outlined below:
- Mortgage rates are what individual consumers pay to borrow money for up to 30 years, with real estate as collateral. By contrast, the fed funds rate is the interest rate that banks charge each other for overnight loans, without collateral.
- Mortgage rates change daily with market forces, whereas the fed funds rate is only reviewed eight times per year and changes are voted on by the members of Federal Reserve Open Market Committee (FOMC).
- Mortgage rates are ultimately based on the premium that loan servicers are willing to pay for loan servicing rights; higher servicing rights premiums paid by loan servicers leads to lower interest rates and, vice versa. Meanwhile, the FOMC sets the “target” fed funds rate based on near and mid-term inflation and employment trends.
In summary, mortgage rates and the fed funds rate serve very different markets and purposes. Therefore, they have different driving factors. And as we recently seen, they are not directly linked on a one-for-one basis in the short or mid-terms.
For example, in September and October of 2019 the FOMC voted to cut the target fed funds rate by .25% at each month’s meeting. Yet, mortgage rates either went up or were unchanged in reaction.
If you are looking for a better market indicator of the day-to-day direction of mortgage rates, it would be more accurate to focus on the yield of the 10-year US Treasury than the fed funds rate. While the 10-year Treasury yield is also subject to different market forces than mortgages, at least it is a long-term rate that is more comparable to the average life span of mortgages.