The Difference Between Federal Funds Rate and Mortgage Interest Rate

1. The Difference Between Federal Funds Rate and Mortgage Interest Rate In your preparations to buy a home or an income property, shopping around for the best mortgage terms is essential. Do you know how to compare term sheets and the difference between the Federal funds rate and your personal mortgage interest rate? We’ve outline the two different rates and their relationship two each other below to help you be more knowledgeable and informed as you prepare to purchase your property. What is the Federal Funds Rate? Financial institutions are required to keep a minimum reserve, and to maintain that reserve they routinely lend and borrow from each other overnight. When this transaction takes place, the interest rate is set and agreed upon by the two financial institutions. The Federal Reserve does not directly set the rate at which financial institutions like banks and credit unions can borrow from each other. They can, and do, set a target rate. The average of all the interest rates between financial institutions is the Federal funds rate, and the Federal Reserve has tools at its disposal to raise or lower this rate by impacting the economy. What is Your Mortgage Interest Rate? Your mortgage interest rate is the percentage of the principal that you owe in interest. Depending upon your amortization schedule you will pay a different amount of interest each month. If you have a fixed rate mortgage, your monthly mortgage payment total will be consistent, but the amount of interest and principal in that monthly payment will vary. How are the Two Related? The mortgage interest rate you are offered by your lender is dependent on a list of factors. There are some factors that are related to your personal finances, like your income, employment history, debt-to-income ratio, credit score, and cash reserves. Other factors are dependent on the economy as a whole. This is where the Federal funds rate comes into play. The rate at which your lender is able to borrow money will impact your mortgage interest rate. When a financial institution has to pay more to borrow money to maintain its reserve, that expense is passed on to you as the consumer.

2. The Bottom Line The ripple effect of a higher Federal funds rate is higher mortgage interest rates. Higher expenses for financial institutions get passed on to you, as the consumer, in the form of higher mortgage interest rates. This usually drives housing prices down, as the cost to borrow increases. However, experts predict that in 2022 prices in the Bay Area real estate market will remain high even as we see changes to the Federal funds rate. As demand for Bay Area housing remains high, you can anticipate a seller’s market for the rest of the year. Real estate professionals do not expect to see significant seasonality in the market this year, as the majority of homebuyers are millennials looking to purchase their first home. Demand for affordable housing will likely increase, even with a higher Federal funds rate. As you see headlines about the Federal Reserve raising the Federal funds rate, you can reasonably expect higher mortgage interest rates to be in the future. If you are otherwise prepared to buy a home, this news might create a sense of urgency to get into the market at the lowest possible interest rate because even small fluctuations in interest rate may affect your budget significantly. With the right team of professionals, buying a home even with a higher rate is still possible. For more information about Bay Area real estate and deciding when to buy a home, contact me today! Amar Realtor offers expert real estate services with proven results in the Cupertino real estate market as well as outlying areas including homes for sale in Milpitas, San Jose, Campbell and properties in San Mateo County, homes in Contra Costa and Alameda County.