PRESIDENT’S PEN

PEN PRESIDENT’S

Federal Funds Short Term Interest Rate vs. Mortgage Rates – How Are They Related?

Bob Yoakam

2022 BIA President Rockford Homes

There is certainly a lot of discussion around interest rates, more so now in a negative light than prior years. However, given our history, is that really warranted or is it that we just forgot?

With the Federal Reserve that typically meets eight times a year, every six weeks raising their short-term rate a total of 2% in the first six months of 2022 with an additional expected 0.5% to 0.75% rate hike in late July, the question that keeps coming up within the building industry is, how does this affect me? (In this issue you’ll read about ways builders and lenders are dealing with rising rates.) Another question being asked is, are consumer mortgage rates directly correlated to the short-term federal funds rate? The answer is not necessarily. The short-term federal funds rate and mortgage rates sometimes move with each other and at other times in history move against each other.

The federal funds rate is the rate that banks charge one another for short term overnight loans. Essentially what this means is these rates are the ones which banks can use to borrow money to lend to consumers.

Often, news is put out in public of an expected rate increase or decrease coming up in a Federal Reserve meeting and by the time the meeting takes place, the mortgage rates already reflect that rate change prior to the rate change technically being implemented. This is because mortgage rates are highly affected by supply and demand. In a rising economy where the economic outlook is that the consumer can afford more, the interest rates may rise. This can also work conversely. Mortgage rates don’t always change daily, but they can and do. Lenders typically send out a daily or weekly interest rate sheet.

Mortgage rates also tend to be tied to the 10 year-U.S. Treasury rate. However, this really isn’t completely factual either. Mortgage rates are mostly tied to the bond market in a supply and demand scenario with bundled mortgages called mortgagebacked securities. As demand for these securities increase, mortgage rates increase, when demand for these securities decrease, mortgage rates typically follow suit.

Another factor which we are currently seeing today is the inflation factor. When inflation occurs, mortgage rates typically follow suit to keep up with that of the currency being lent on.

And lastly, of course there are many personal factors affecting your mortgage rate like term (3, 5, 7, 10, 15, 30 years), fixed versus adjustable, loan to value, and credit worthiness.

Most mortgage lenders have different appetites for risk and market sectors as well.

Mortgage rates back in the 1980s reached anywhere from 13% to 20% depending on the borrower and situation! Think about that. The millennial generation has never seen rates above 7%!

Mortgage rates in the early 2000s housing growth period were anywhere from 7% to 8%. Mortgage rates coming out of the 2007/2008 recession were anywhere from 4% to 5%.

Mortgage rates may never go back to what we saw in the COVID-19 pandemic era of low 2%’s to 3%’s. This was a time of unprecedented social economic factors and stimulus by the United States government.

Today mortgage rates are in the 4% to 5% range, which historically speaking is extremely affordable.

Only time will tell as to where they move but one thing is for sure, this market is still a good market from a mortgage interest rate history perspective when we look at our history of where we’ve been.