Depending on how much of a finance buff you are, you may or may not have heard that the Federal Reserve lowered interest rates for the third time this year in October. And again depending on how much you pay attention to economic news, your reaction might be anything from, “Hm, I wonder if this means a bearish shift for the economy,” to, “Exactly why should I care?”
If you’re a homeowner, the Fed’s interest rate cuts and hikes can affect decisions you might be considering about your house. Read on to see how mortgage, credit, and even the asking price of the house down the road can be influenced by the Federal Reserve.
What is the Fed?
The Federal Reserve System, or the Fed to its friends, is the central banking system of the United States. Its job is to help keep the U.S. economy running smoothly. The Fed monitors economic trends and policies, promotes consumer protection, and keeps an eye on individual financial institutions (e.g., banks) to assess their impact on the financial system. The goal: A healthy economy with strong employment rates, stable prices, and moderate long-term interest rates.
Why does the Fed change interest rates?
The Fed pays close attention to economic trends. If you imagine the financial institutions of the United States as a big bus, and the economy as a (sometimes bumpy) road, the Fed uses interest changes as a way to shift gears or adjust the steering wheel to handle different economic terrain.
The Fed’s interest rates set the amount that banks charge other banks for overnight lending. It’s basically an indication of how much it costs for financial institutions to use money. Banks can still set their own interest rates, but in most cases they adjust their rates to follow raises and cuts from the Fed.
If the economy hits a slump, or looks like it’s trending that direction, the Fed lowers interest rates. If the economy is booming too fast, the Fed might use higher interest rates as a tool against rapid inflation. The sweet spot is generally somewhere in the 2-5 percent range. The Fed just lowered rates to a range of 1.5-1.75 percent, which makes some experts speculate that the Fed is feeling pessimistic about the current economic direction.
Is the U.S. economy in trouble?
Not necessarily. The Fed doesn’t only review economic information within the country. It examines global trends that could lead to economic ups and downs. As of the end of 2019, unemployment rates are low, and overall economic growth looks good. Global trade wars and other signs of a shakier global economy can prompt the Fed to be conservative and lower interest rates to protect the economy. The U.S. economy might still end up taking a hit, but an interest cut doesn’t automatically mean that’s happening.
Will the Fed rate affect mortgage rates?
If you only use a mortgage to manage your home’s financing, you may or may not see the effect of a Fed rate cut. Even if your mortgage has a variable interest rate, mortgage rates don’t always follow the Fed. Credit cards, which tie their interest to the banking prime rate, and of course banks themselves tend to respond much more quickly to Fed interest changes. Home loan interest is more closely related to Treasury yield.
That said, both the Fed interest rates and long-term loan rates like mortgage are tied to similar economic expectations. The Fed’s rate cut can be a sort of weathervane here, indicating that a negative economic outlook could influence mortgage lenders to cut rates, too.
It’s possible that a variable interest rate on your mortgage could change in response to this latest Fed interest rate cut. What’s even more important, though, is how this change might affect other aspects of home financing, and the broader home market.
Buying, selling, or refinancing after Fed interest rate cuts
Your mortgage might see a change in response to a Fed rate increase or decrease, usually after some lag time for other market factors to catch up. Here are a few other areas homeowners should follow when the Fed makes a change.
HELOC and similar home equity agreements
We’ve looked at why a mortgage might not be affected by a Fed rate change, but not all homeowners rely solely on a mortgage for home financing. A home equity line of credit, or HELOC, is one popular option for homeowners who want to access part of their home’s equity value. As a form of credit, HELOCs often use the prime rate to determine interest rates. That means looking to banks, and therefore the Fed.
Buyer vs. seller home market
Changing interest rates can also affect the real estate market where you live. Higher interest rates mean higher home costs, after all. A difference of 1 percent on the interest for a $300,000 home on a 30-year mortgage can translate to more than $100 difference on the monthly payment. For many hopeful homeowners-to-be, this might be a make-or-break figure.
Home sellers may find themselves adjusting their asking price around interest. A higher interest rate might lead some sellers to drop their asking price, so the heftier interest doesn’t turn buyers away. It’s possible that a reduced interest rate could bring out some more buyers, potentially increasing competition and making it easier for sellers to command a higher price for their home.
Home appraisal values
A seller’s market can also mean good news if you’ve got a home appraisal in your future. Professional home appraisers rely on sales of comparable homes in your area, or comps, as part of the data they use to calculate your home’s value. If other homes in your neighborhood are appreciating in value, yours probably will, too.
Now, this doesn’t mean you’re going to see the effects of a 0.25 percent Fed interest rate reduction immediately. Lower interest leading to higher home prices and increased appraisal value can take a little time. But when interest rates change, it’s not a bad idea to check in on home sales in your area from time to time, to see what the market looks like.
Any of these changes are likely to take some time, and a small interest rate change may not move the needle much at all. The next few months may show actual outcomes more clearly. If you’re new to following the connection between the Fed and home financing, though, it’s always a great time to learn.