The Fed funds rate is the rate at which the Fed lends money to banks, and banks lend money to each other, NOT the rate that consumers borrow at.

When the Fed raises the Fed funds rate, it is generally to fight inflation.  Beginning in early 2022, inflation began to skyrocket, and throughout 2022 and so far into 2023, the Fed has consistently raised their rates to curb inflation.  While inflation has slowed, recent data points to inflation being higher than the Fed’s target rate, and for this reason, rate hikes have continued into Q2 2023.  Future rate hikes will depend on the direction of inflation from here.

It’s important to note that mortgage rates are not directly tied to the Fed’s actions.  Since high inflation results in high mortgage rates, the Fed rate hikes often help bring mortgage rates down, since reductions in inflation lead to reductions in mortgage rates.  Some other financial products are, however, tied directly to the Fed funds rate.  The “Prime rate” for example, moves in direct correlation with the Fed funds rate, so credit card rates will move up in line with the Fed funds rate.

Since early 2022, the Fed has raised their Fed funds rate by a total of 5%.  That means credit card debt has become 5% more expensive for consumers to carry, and other types of debts have become more expensive as well.  Mortgage rates, though, have come down substantially since their highs seen in October 2022, despite additional Fed rate hikes.

The Fed has signaled that they’ll rely on data and economic figures to determine the future direction of the Fed funds rate, but most forecasts predict the cycle of rate increases is either at or near it’s end, as inflation numbers and economic conditions seem to be shifting.

Mortgage rates improved on the day, and have come down substantially from October highs and another recent spike in February.

For questions about the Fed rate hike, mortgage rates, or anything else housing or mortgage related, you can ask an expert here and get answers instantly!

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The most recent rate hike brings the Fed’s target funds rate (the rate which banks borrower from the Fed and each other) to a range of 3-3.25%, a full 3% higher than 0-.25% range we saw prior to inflation kicking in late last year.

This also moves the “prime rate” (a very important metric to the overall economy) up to 6.25%, also 3% higher than last year’s lows as the prime rate, unlike mortgage rates, does more in direct proportion to the fed funds rate.

What does this mean for mortgages and home financing?

The Fed’s moves are closely watched by mortgage bond traders (and mortgage bonds, or mortgage backed securities, are what directly influence our rates), and just as important as the Fed’s move on rates is their commentary after announcing their rate decision.  The market reaction to this Fed move was mortgage interest rates moving initially higher (opposite to the market reaction of the last Fed rate hike of the same amount back in June!), as the market’s seem to doubt the Fed’s ability to reign in stubborn inflation.

Historically, though, Fed funds rate increases are usually followed (sometimes quickly) by recession, which historically has brought rates back down to earth.  While no one has a crystal ball, with pending recession grabbing more headlines, it seems like history may repeat itself, but that remains to be seen as the Fed’s rate hike will typically take a few months to be absorbed and show it’s impacts in the broader economy.

As the Fed funds rate increases, recession typically follows (indicated by the gray areas)

What Does The Fed Rate Hike Mean For the Broader Economy?

With a Fed rate hike, the ‘prime’ rate increases, and many household financial products are tied to prime, most often credit cards and home equity lines of credit (HELOCs).  So these products will get more expensive and will likely be the biggest direct impact households will immediately see & feel.

Higher borrower costs tend to mean less borrowing and a slowdown to the broader economy, so over time the Fed rate hikes should reduce inflation, which is a good thing!  The negative side of the equation is that while reducing inflation, the economy usually slows and often ends up in recession.  With inflation hitting so many households in the wallet this year, though, the Fed’s primary concern is to reign in inflation and lower costs for US households.  If their actions do cause a recession and a spike in unemployment numbers, their focus will shift, but for now, we can expect the Fed funds rate to continue to increase and remain at higher levels until we start seeing inflation numbers come down.

Is Housing a Concern?

Housing is certainly seeing a shift in 2022 from the insanity of quickly appreciating values in 2020-2021, but inventory is still below historical levels, so the market has some room to absorb reduced demand without a huge impact.  Again, while no one has a crystal ball, the numbers seem to support strength in the housing market, even if we do see a slowing in appreciation or some slight depreciation in some markets.  The greater concern for the housing market is interest rates, which have hurt affordability in housing, as even with rising prices, low rates can keep housing payments down.  If we see rates drop as inflation comes down, it could bring more home buyers to market.

The Fed has states they plan to continue to raise rates until inflation shows sustained improvements, and they have made fighting inflation their primary focus for the short term.  What the overall impacts will be and the direction of the economy as a result of their actions remain to be seen, we’ll be sure to provide up to date info on the state of housing, rates, and how the Fed’s actions are impacting our markets.

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Today the Fed increased their Fed Funds rate by .75 percent.  While on the surface that doesn’t seem like too big a bump, this is the largest single-day increase to the Fed funds rate since 1994, signaling a serious attempt at Fed members to reign in inflation.  The move comes on the heels of last weeks surprisingly high inflation report which shook up the markets and led to losses in equities markets and steep and fast increases to mortgage rates.

There is often a lot of confusion around the Fed Rate Hike and how it actually affects the mortgage market, so we hope to clear up some of the common misconceptions.

1. No, mortgage rates do not go up when the Fed Rate Hike happens

Mortgage rates are influenced by many things, but one of the biggest factors in the percentage rate offered to mortgage applicants is inflation.  When inflation is high (as it has been for all of 2022 thus far), mortgage rates are higher.  When inflation is reduced, mortgage rates usually come down with it.  Since the Fed rate hike is intended to reduce inflation, the result is often reduced mortgage interest rates, though sometimes it takes time for rates to come down a noticeable amount.  Today, however, the mortgage bond markets gained huge ground upon the Fed rate hike announcement and commentary, so improvements in rates were felt almost immediately for mortgage applicants.

2. Other debts will get more expensive, immediately.

The “prime rate” is tied directly to the Fed funds rate, and many of the most common types of debt are tied to prime.  Credit cards and home equity lines of credit are two of the most common debt vehicles that do go up and down based on the Fed movements, so with the latest Fed rate hike, it can be expected that credit cards and home equity line of credit rates will see an identical .75 percent increase in their cost.  Since more fed rate hikes are expected throughout 2022 as the Fed continues to fight inflation, it can be expected that this revolving debt will continue to get more expensive on a monthly basis for anyone carrying this type of debt.

3.  Does a Fed rate hike mean recession?

Recession has been a hot headline recently, and for good reason.  Many economic indicators currently point toward the US being in or heading toward a recession, however Fed rate hikes don’t necessarily mean recession.  It’s important to note though, that rate hikes usually lead into recession.  The reason is that higher rates cool off a hot economy by making borrowing more expensive.  When borrowing is more expensive, there tends to be a ripple effect in the economy that often hits the job market (leading to increases in unemployment), and slows inflation, cooling the GDP and often leading into consecutive quarters of negative economic growth, which is the technical indicator of recession.  Since we don’t know we’re in recession until we have 2 consecutive quarters of negative GDP, it’s impossible to say if we’re in a recession or will be soon, but it’s likely the Fed rate hike (and subsequent rate hikes) could point toward recession sooner than later.

4.  Does the Fed rate hike impact other rates and payments?

Through the same ripple effect, the Fed’s actions indirectly affect many aspects of the economy, but what the Fed funds rate actually is, is nothing more than the rate banks borrow from each other and from the Fed.  When banks are borrowing for free or nearly free, as we’ve seen over the past several years, it allows them to offer lower rates and still profit.  When their borrowing costs go up, to maintain the same margins of profit, the rates they offer consumers also have to increase, which is why borrowing becomes more expensive almost across the board.  Mortgage rates are somewhat of an exception because of the impact Fed rate hikes have on inflation that we noted above.

5.  How low will mortgage rates go?

No one has a crystal ball when it comes to mortgage rates, but historically in times of a Fed rate hike, and moreso in times of recession, interest rates decline.  2022 has brought some of the steepest increases we’ve ever seen in terms of how quickly rates have risen, and it remains to be seen if a decline could be just as steep, especially considering the weird market conditions related to COVID-19 that brought us the historically low rates of 2020 and 2021.  If you’re considering applying for a loan, your best bet is to talk with a MasonMac loan officer to determine which options are presently available, and what type of loan product and rate best fits your financial needs!

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So let’s look at an example.  In 2006, we’ll take a home worth $300,000.

Price: $300,000
Rate: 6%
Monthly Payment: $1,800

Household income: $6,000/month
% of monthly income that goes to the mortgage payment: 30% 

Now let’s look at that same home in 2021

Price: $423,000 (up 41%)
Rate: 3%
Monthly payment: $1,783

Household income: $9,300 (up on average 55% since 2006)
% of monthly income that goes to the mortgage payment: 19%
These are the averages nationwide, and of course numbers will be different for every person, situation, and things vary by region, but on average, the market is about 11% more affordable today than it was in 2006.

Further, housing still has room to go – with supply lagging far behind demand and a generation of first time buyers coming of age, nearly all forecasts point to further home appreciation.  Add in supply-chain issues, inflation, and many other metrics and signs point to affordable housing being a very realistic thing.  That means today is a great time to buy, despite steep competition and high price tags.  To see what options you have in your area, you can contact your MasonMac loan officer, or contact us with questions by asking an expert here!

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One of the most common myths in the mortgage world is an oft-misunderstood aspect of refinancing when it comes to the first payment date of a newly originated/refinanced loan.  Many times consumers and loan officers alike are confused by the timeline of having one loan paid off and payments begin to take place on a new loan.  Due to this misunderstanding, the term “skipping a payment” or “skipping 2 payments” is often tossed around without any real explanation or understanding of how “skipping” a payment works.

The easiest place to start to understand how the process works is to understand that mortgage interest, unlike a lot of other types of financial interest, is paid in arrears.  That means that when a payment is made on a mortgage loan, the interest portion of the payment is actually the interest due for the month before the payment is made.  For example, a May mortgage payment includes a portion of principal, plus the interest accrued for April, the month prior to the payment due date.
In addition to interest being paid in arrears, the other piece to the puzzle is in the form of “per diem” interest that shows up on a borrower’s closing disclosure (CD).  On the CD, per diem interest is charged from the date a new loan funds through the end of that current month.  For example, if a new loan funds on the 15th of a 30 day month, one of the charges on the CD will be 15 days worth of interest.
Now let’s look at an example of calendar days, closing days, and how that magic “skipped” month happens.  We’ll use a loan closing June 15th as an example.  A loan funding June 15th will have a first payment due date of August 1.  Since there’s no payment in July, you skip a month, right?!  Not quite.  On the closing statement, per diem interest will be collected from June 15th through the end of the month.  On August 1, the payment made will cover interest for the entire month of July, since mortgage interest is paid in arrears.

In some instances, “you can skip 2 payments!” is pitched as a benefit of a refinance.  In reality, this is never the case.  This is typically done by closing a loan early in a month.  We’ll stick to our example of a refinance loan closing in June.  If a customer doesn’t pay their current lender for June’s payment, and we refinance their loan with a first payment date of August, technically no monthly payment is made for June OR July.  But does that mean 2 payments are “skipped”?  Not really.  Take our previous example into consideration, and we already know that July’s interest is paid with the August 1st payment.  The remainder of June’s interest is paid in “per diem” interest at closing, and the “extra month” is really just interest added to the current lender’s payoff – or in this case, just being transferred to the new loan.

So when it comes to “skipping payments”, refinancing doesn’t ever accomplish that.   That said, borrower’s do not have to physically make monthly payments the month following signing closing documents, but it’s important to remember that the interest is always paid one way or another.  All of the interest on the loan being refinanced is wrapped into the payoff and closing figures on the new loan, and the new loans interest is paid in full beginning with per diem interest on the closing documents, and continuing to be paid with payment #1.

This mortgage myth is one of the more complex issues, and for that reason, consumers AND many mortgage professionals are often confused when discussing “skipping payments”.  The correct wording to use for what’s really happening is “deferring interest” or “including more interest in a payoff”.   So the next time you see someone advertising or telling you you can “skip a payment!”, rest assured you know better – and then make the decision on when to close your refinance loan based on reality.

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