How Does the Fed Affect Mortgage Rates?

What Does the Federal Reserve Do?

The Federal Reserve is the U.S. central bank. Its mission is to promote health and stability in the country's banking system and overall economy.

One way it does this is by directing the nation's monetary policy, primarily by raising and lowering the federal funds rate—the interest rate at which banks lend to each other overnight.

The federal funds rate directly influences the short-term interest rates financial institutions charge on credit cards, personal loans, auto loans and variable home loan rates. Lowering the rate can help spur economic growth through increased consumer spending, while raising it can help temper high inflation by reducing consumer spending.

How Does the Federal Reserve Affect Mortgage Rates?

The Fed doesn't set mortgage rates. However, its monetary policy can have an indirect influence on the interest rates that home lenders charge.

Mortgage loans have longer terms than other forms of consumer debt. As a result, lenders typically use the 10-year Treasury note yield as its benchmark because its duration is closer to the average duration of a mortgage loan.

The 10-year Treasury note is influenced by several factors, including the Fed's monetary policy, economic growth and inflation—all of which involve the federal funds rate.

But here's the kicker: The Fed's current monetary policy may wield some influence on the 10-year Treasury yield. However, investors' expectations of future monetary policy, along with other economic indicators, are far more consequential. So, if the Fed lowers short-term interest rates, lower mortgage rates aren't necessarily inevitable.

To better illustrate the relationship, here are two scenarios:

• If the Fed lowers the federal funds rate and investors expect short-term rates, inflation and economic growth to continue to decline, the 10-year Treasury yield will typically fall, with mortgage rates following suit.
• If the Fed lowers short-term rates but investors expect high inflation or hot economic growth—or they generally remain uncertain about the future of the economy—mortgage rates may not change. In some cases, they may even increase.

How Does Inflation Impact Mortgage Rates?

As previously mentioned, inflation has an influence on the 10-year Treasury yield, which means that it can also affect the rates that mortgage lenders set.

If investors expect the inflation rate to rise, they typically demand higher Treasury rates as compensation for the loss of purchasing power, potentially leading to higher mortgage rates.

In times of lower inflation, investors are willing to accept lower rates because they're not concerned about rising prices eroding the value of their returns. This, in turn, can lead to lower mortgage rates.

At the same time, the Federal Reserve will typically raise short-term interest rates in response to higher inflation to help curb consumer spending, which can help bring the inflation rate back down. During low-inflation periods, the Fed may lower the federal funds rate to stimulate borrowing and spending and bring inflation to a healthier level.

Will Mortgage Rates Drop in 2025?

Some experts anticipate that mortgage rates will reach close to 6% by the end of the year. That said, mortgage rate forecasts can change frequently based on a variety of economic trends, so there are no guarantees.

In particular, uncertainty surrounding the Trump administration's tariff policy and its impact on the economy make it difficult to see a clear path forward.

How to Prepare for Future Mortgage Rate Shifts

Regardless of which direction mortgage rates go in the coming months and years, it's important to take steps to improve your chances of securing favorable terms when you're ready to buy a home or refinance your mortgage loan. Here are some steps you can take:

• Improve your credit score. Sign up with Experian to get free access to your Experian credit report and FICO^® Score^☉. If your score needs some work, use these resources to help determine what you can do to improve your credit.
• Lock in rates early when possible. When declining rates aren't a certainty, talk to your lender about locking in your rate as early as possible to protect you from potential rises. If rates do decline, you may be able to take advantage of a float-down option with your chosen lender or even apply with another lender.
• Make a bigger down payment. The more money you put down on your home purchase, the less you'll need to borrow. Additionally, lenders may be willing to give you a lower rate, spelling further savings.
• Closely monitor the market. You don't need to be an economist to get a general idea of how the economy is doing. It can help to occasionally read up on the latest financial news and mortgage rate forecasts to get a feel for when the timing is right to apply.

The Bottom Line

The Federal Reserve's monetary policy, including its control of the federal funds rate, can have an indirect influence on mortgage rates. However, the relationship between the two isn't always clear cut.

Understanding the different variables that influence mortgage rates can give you a better idea of what to expect in the future, especially if you're planning to buy a home or refinance your existing mortgage.

Market conditions aren't the only factor determining your rate, however. It's also important to take steps to build and maintain a good credit score, shore up your finances and maximize your chances of securing favorable terms. Regularly monitoring your credit can help you stay on track for your next mortgage loan.