How many times have you heard a radio advertisement for a mortgage company shout at you that while mortgage rates are low, the “Fed” will be raising rates soon and you could miss out on a great opportunity?  Is that true?  What does it mean?  How does the action of the “Fed” (whatever that is) impact mortgage rates?  As a first-time homebuyer (or a first-in-a-long-time homebuyer), these can be confusing questions that aren’t easily answered by listening to a 30-second radio ad while driving 65 MPH and trying not to spill hot coffee on yourself.  But before you ever apply for a mortgage or buy a home, you really need to understand what forces impact your mortgage rates, since you’ll be living with that rate for as many as 30 years!

Mortgage Rates Historically

First, let’s confirm one thing – mortgage rates ARE historically low right now!  As anyone over 50 what rate they paid for their first home, and you can be sure it didn’t start with a 4 or a 5.  According to Freddie Mac, here are the average annual mortgage rates over the years:

1972: 7.38%

1982: 16.04% (!!)

1992: 8.39%

2002: 6.54%

2012: 3.66%

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As you can see, mortgage companies and that uncle of yours aren’t kidding when they tell you how great mortgage rates are today (4.17% during February).  But why are they low, and what (or who) makes them change?

The Fed and Mortgage Rates

Mortgage rates, which help determine the amount of interest you pay on your mortgage (see last week’s blog for a closer look at how interest and principal are paid over the life of your loan), are impacted indirectly by the activity of the Federal Reserve (the “Fed”), the government body tasked with setting monetary policy.  The Fed doesn’t have the authority to determine mortgage rates; rather, they set a target for the federal funds rate.  This is the overnight rate at which banks can borrow from each other to maintain their reserve levels.  When this rate is increased, the cost of borrowing goes up for all players in the economy (in particular, the interest rate on 10-year Treasury Bonds increases) and banks and financial institutions react by increasing the interest rates on other types of borrowing, including mortgage loans.

In short, when their costs of lending go up, so do yours.  The same ripple effect you feel when the cost of groceries goes up following a spike in gasoline prices.  That’s why mortgage lenders keep a close eye on regular meetings of the Fed and look for clues as to what they will do next, as that helps them anticipate and set their consumer mortgage rates.  Many analysts predict that the Fed may raise rates two more times this year, which means mortgage rates are likely to be higher by the end of the year.