If I get a tea bag every time someone call me in a panic about their mortgage rate after some press conference held by the Federal Reserve, I’d have probably opened my own tea house by now.
The primary task that the Federal Reserve do (at least in the eyes of the public) is to set the rate in which banks borrow from one another. The organization also controls the rate at which the Federal Reserve Banks lend short terms loans to commercial banks.
It does not mandate, order or set the interest rates that consumers have to pay for their home loans.
In addition, short term interest rates ironically seldom affect mortgage rates in the short term.
The impact which the central bank has on mortgage rates are at most indirect.
This is because changes in Fed Rates affect the costs of money, which is the product lenders sell to consumers and businesses.
When we consider that mortgage rates are around 5%, a 0.25% hike in Fed Rates only has a minimal impact on the finance costs of lenders.
However, as lenders are profit driven, they often use Fed Rate hikes as excuses to raise their rates on consumers. When in actuality, their bottom line is not significantly affected by Fed rate increases if it is as minute as 0.25%.
The absence of a direct link between fed rates and mortgage rates can be easily observed in the all too familiar situations where the former tanks but the latter don’t follow.
So in reality, changes in home loan interest rates are decided by lenders.
The Fed only plays an indirect role by giving lenders a justifiable reason to raise their own rates.
While lenders have the freedom to quote their own rate to their customers, they wouldn’t go all out to fleece us as they have to also consider the dynamics of the open market.
In the open market, mortgage rates are more affected by long term treasury bond rates.
This goes back to the topic of mortgage-backed securities available in the secondary market.
As mortgage-backed securities are competing for investor eyeballs, they need to have a better return (interest rate) compared to bonds in order to entice fund managers and investor to buy them for their portfolios.
This is why 30-year mortgages are often compared to 30-year treasury bonds in the world of equities.
If a bond offers a better return than a mortgage, then a pragmatic investor would put his funds into bonds rather than lend them out as mortgages.
To keep up with the yield offered by bonds, mortgages have to closely keep track with the prices of bond to keep investors happy.
To summarize this, the Fed controls the fiscal policy for the economy. Lenders determine for themselves the rates they charge to consumers.
Just because the fed rate has increased or decreased does not mean an immediate impact on your home loan.
How much a lender decides to profit for the year would determine the mortgage rates they charge to borrowers.
And let’s not forget that interest rates are just one of the many components that enable lenders to generate revenue.