Fed Funds Rate vs Long-Term Mortgage Rates

[Doug Smith]

Many of you are savvy lenders, bankers, or investors and you already know this, but I realize that some of you are here to learn and I hope this helps. I received a call from an someone today that said “it looks like mortgage rates are coming down because I heard the Federal Reserve is lowering rates multiple times before year end.” Mortgage rates may, indeed, come down, but contrary to popular belief, the rates on 30-year mortgages and the rates that the Federal Reserve raises and lowers are not directly tied to one another. Hopefully, this will explain the difference and how you can watch what direction rates are going.

The Federal Reserve, the Central Bank of the United States, serves several functions. “The Fed”, in theory, is independent of the Executive Branch (the President) and has a mission to accomplish two things, known as a “Dual Mandate”. They are supposed to balance 1) having a strong economy and 2) keeping inflation under control. They do this in several ways including the raising and lowering of the “Federal Funds Rate (Fed Funds Rate)”, or the rate at which member banks can borrow money in the short term from The Fed or from other member banks. When the economy is doing well, we might experience prices that go up too quickly, or inflation. To curb inflation, they will raise the Fed Funds Rate in hopes that increased rates mean businesses will slow their activity which, in theory, keeps prices down. If the economy slows too much, they will lower rates in hopes that it will allow for more borrowing which leads to more spending, which means a hotter economy. It’s tough to balance and, historically, the Fed has tended to move way, way too late one way or the other. That being said, these rates are “SHORT-TERM”…not the longer term rates that mortgages use.

Let's move to longer-term mortgage rates like Conventional Loans, FHA Loans, VA Loans, and 30-Year DSCR Loans on Rental Property. Enter the "Mortgage Backed Security", or MBS for short. In order to afford a home, most people need to pay over a longer period of time, normally 30 years. The Fed Funds rate for short-term borrowing is simply too volatile. Conservative investors like pension funds might buy US Treasury Bonds/Bills to be "safe", but what if they want to stay relatively safe, but add a little "juice" to their investment portfolio? They can invest in a MBS. A Mortgage Backed Security is an investment, similar to a bond, in a huge portfolio of many, many mortgage loans. The investor will invest in these pools, also known as "traunches" of loans that all of similar "quality". Although safe, they aren't in theory quite as safe as a US Treasury Bill/Bond, so the rates will be a bit above the Treasury Rate. That's why mortgage rates move up and down in lock-step with the US Treasury. We lenders use those pools of money to create the 30-year fixed rate loans that we lend to our borrowers. The loans are then "sold" into those traunches. Without this process, the longer-term fixed rate mortgage would not be possible. Of note, this is why we have to adhere to "underwriting guidelines". These MBS traunches have to stay consistent with what they promise investors, so all of the loans in the MSB traunche MUST meet the stated guidelines. When we ask for bank statements, paystubs, lease agreements, or whatever we lenders ask for, know that we have to in order to get the money from the traunche to fund your loan. Otherwise, they wouldn't be able to fund the loan and you, because you wouldn't cough up that bank statement, can't get funded.

When the Federal Reserve decides to change their Fed Funds Rate, it might influence but it does not have a direct impact on Long-Term Mortgage Rates. Mortgage Rates move up and down with the bond market…namely the US 10-Year Treasury. The Fed Funds Rate is deliberately (I might say arbitrarily) set by the Federal Reserve. They are, indeed, different.

If you want to track mortgage rates and you have a smart phone, there are two ways to do this. First, watch the 10-Year Treasury. If you have a smart phone, it’s “TNX” on your stock ticker ap. Save that to your watch list. The mortgage rates will usually be anywhere from 2% - 2.5% on average above the 10-Year Treasury and it will move up and down in lock-step with it. Riskier loans will be higher...safer loans will be lower. You can also download “Mortgage News Daily” as a free ap on your phone. They publish the national average mortgage rates along with articles about rates and housing. 

I hope you found this helpful.