You’ve likely heard many times over the past decade that the Federal Reserve has increased the fed funds rate. While this news may give you the urge to yawn, it’s important to take note because a rise in the fed funds rate could mean serious changes in how much you pay for your mortgage every month.
Before we get into what rising federal interest rates mean for homeowners, let’s talk about what the fed funds rate is.
What is the fed funds rate?
The fed funds rate is the interest rate set by the Federal Reserve Board (aka the Fed), which determines the rate at which banks borrow money from one another. This rate directly affects the prime rate, treasury bonds and the Wall Street Journal Index, which are the three main indexes that lenders use for loans, such as credit cards and mortgages.
Mortgage lenders determine the rate they offer to customers like you by using one of these indexes as a base rate and adding a margin, which is based primarily on the amount of risk associated with a loan. So, if the base index rate goes up, so do the interest rates that lenders will offer you.
The Fed raises and lowers the fed funds rate in response to how healthy our economy is. Lowering the rate can lessen the severity of a recession and raising it can help slow inflation.
Impact on a fixed-rate mortgage
If you have a fixed-rate mortgage, you may be thinking you don’t have anything to worry about if the Fed raises their rate. And you are absolutely correct. If you have a fixed-rate loan, you paid a slightly higher interest rate than an adjustable-rate mortgage (ARM) because fixed-rate loans come with the security of an interest rate that will never change, no matter how many times the fed funds rate increases.
However, if you are interested in refinancing to a new fixed-rate mortgage, buying a second home with a new fixed-rate mortgage or taking out a fixed-rate home equity loan, a rise in the fed funds rate will increase the interest rate — and the cost — of any of those loan types.