Do Federal Reserve Rate Cuts and Affect Mortgage Rates?

There is so much discussion in the media about the feds cutting interest rates. This seems great, but leads one to wonder "which rates?" There are so many interest rates out there and the media and financial analysts talk about "the rates" as if we as Americans should already know what they are talking about. The fact of the matter is, we don't have a clue. We just nod our heads in agreement to save face and act like we understand it all perfectly.

Here is the low-down on what the Federal Reserve does. The Federal Open Market Committee (FOMC) is the financial decision making body of the Federal Reserve System. It is responsible for creating monetary policy which will hopefully promote economic growth, increase the employment rate, and stabilize prices. They hold eight meetings a year to determine the federal funds interest rate. This is the interest rate that is discussed by the media.

The federal funds interest rate is the interest rate banks pay when they borrow money from one another. The Federal Reserve requires banks to maintain set reserves that they have available at all times. If they fall below their limit, they borrow money from another bank until their reserves come back up. Usually this money is only borrowed overnight until a payment comes through the next day. Fortunately, unlike average Americans, banks can't float money hoping a check won't clear before payday. The feds fund rate is used to control the amount of money that is available, which consequently controls the supply of accessible money.

The federal funds rate determines short term debt interest rates. Revolving credit card debt and savings account interest rates are set based on the federal funds rate. These rates are set at prime rate, which is three percentage points above the federal funds rate. If you have credit cards and savings accounts, this affects you.

So what does this have to do with mortgage rates? The monitoring and tweaking of the federal funds rate keeps the economy in check and potential recession at bay. This in turn influences the emotions of the investors of home mortgage loans. If they like what they see in the economy, they wait to buy mortgage loans until they can make more money on the interest, which in turn drives the mortgage interest rates up. If they are nervous about a potential downswing in the economy, they buy mortgages while they can still make money on the interest causing the mortgage rates go down.

So, in the end, the federal funds rate is one cog in the giant clock work of the American economy. One cog turns another that turns another. No single piece of information determines the interest rates or the economy. Thankfully no one cog is the driving force, since if the one determining factor came to a screeching halt, our country would be in a crisis.

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