Will mortgage rates rise because the fed raised the federal funds rate? If you’re speaking to a real estate broker who is completely inept when it comes to the bond market, then their answer will likely be a resounding YES! However, the true answer is much more complicated than that. The truth of the matter is that the “fed funds rate” that the FOMC (Federal Open Market Committee) influences actually has very little affect on mortgage rates and they are most definitely NOT directly correlated.
I will try to keep this as simple as possible, since this material can definitely get quite dry, but it is important to understand a few basics. The “federal funds rate” is simply the overnight rate that banks charge each other. Why do banks do this? Well, the law says that each bank must keep a certain percentage of deposits on reserve at all times. Obviously each bank wants to put their money to use so they try to keep their reserve deposits to the absolute minimum. Well, at the end of each day some banks may be a bit short and some may have excess reserves. The bank with excess reserves will simply lend “overnight” to the bank with a reserve shortfall. The fed funds rate is essentially the “overnight rate.”
There are some interest rates that consumers experience that are directly correlated with the fed funds rate but these are typically the shortest term loans / credit. For instance credit card interest rates for instance are typically tied the “prime rate” which typically hovers a few percentage points above the fed funds rate. These are considered short term loans. Car loans typically range from 3 to 6 years and therefore can be exposed to greater influence by the fed funds rate.
But what about mortgage rates? If you really want to follow mortgage rates then you need to follow the bond market. The bond market is an interesting animal and while it may react in the short term to a fed funds hike the bond market is much more interested in what the fed has to SAY versus what they do. Mortgage rates are tied to what bond investors need, versus what the fed’s target rate is. Let me give you an example and I’ll thank Bankrate.com for providing the following information in such a simple manner. “Starting in June 2004, the Fed raised the federal funds rate 17 times in two years. And what happened at first? Mortgage rates fell during the summer and fall of 2004. Back then, the Fed’s rate hikes caused investors to become less concerned about inflation, so mortgage rates fell.”
Now, let us think back to 2017. In 2017 we had three fed rate hikes, but what happened? Rates remained relatively flat. It wasn’t until the start of this year that we saw an increase.
What does all this mean? Am I saying that rates are not going to go up? No, I am not saying that. All I am saying is that there is not a direct correlation between the fed funds rate and mortgage rates. The answer is a bit more complicated than that. The fed may exert some influence over mortgage rates, but that influence can work in either direction!
The reasoning for writing this blog post is because when I opened my Facebook app this evening I saw almost a dozen posts from fellow real estate brokers shouting about how the time is NOW to buy because rates will SPIKE! Some even called for 7% interest rates by the end of the year! To those consumers reading this, I apologize on behalf of these brokers for they do not know what they are talking about and are only using fear mongering in order to obtain your business. That is wrong.
To my fellow real estate brokers posting that the FOMCs decision today will immediately hike mortgage rates, I implore you to educate yourself on how the bond markets work. You look stupid and do a disservice to your clients and your industry with your blatant ignorance. As real estate brokers it is our responsibility to properly understand market dynamics and inform our clients with such knowledge so they can make an informed decision. Anything less is the equivalent of malpractice.
Paul Blackburn is an Illinois licensed Real Estate Broker and Realtor with @properties in Chicago, IL. He can be reached anytime via e-mail at Paul@PKBlackburn.com
To learn more about FOMC and Mortgage rates here are a couple helpful links.