Federal Rate Vs. 30 Year Mortgage Rate

Federal rate

The "Fed rate" is short for the federal funds rate. This is the overnight interest rate that banks charge each other to borrow money. It's among a number of key interest rates that the Federal Reserve's Open Market Committee sets. The federal funds rate gets more attention in the media than any other interest rate. Close attention is paid to the Fed each time it meets to set this rate.

30-year mortgage rates are the interest that a bank charges you to take out a long-term fixed loan to buy a home. These rates change daily. Mortgage rates vary widely depending on a number of factors including the credit score of the borrower and the type of mortgage. Rates on shorter-term adjustable rate mortgages are typically lower than longer-term fixed rates, but 30-year fixed rates allow you to calculate an exact payment for the life of the loan. Web sites such as Bankrate.com offer the latest mortgage rates.

The Federal Reserve's Open Market Committee (FOMC) meets eight times a year to set a target for the federal funds rate. The market establishes the exact short-term interest rate within this range. The Fed typically lowers the rate to stimulate the economy and raises the rate when it believes a pullback is needed to stave off inflation. The stock market typically cheers lower rates and pans higher rates.

30-year mortgage rates are set by a number of factors, including demand of funds and anticipated inflation. Longer-term rates rise when investors expect inflation, since inflation saps the purchasing power of the monthly mortgage payment. There is very little correlation between the short-term federal funds rate and longer-term mortgage rates. For example, at the end of 2009, the Fed funds rate was close to zero, while 30-year mortgage rates were above five percent.

The Fed can't greatly affect 30-year mortgage rates with the federal funds rate, but it does have other tools at its disposal. It can purchase mortgage-backed securities to drive down the price of long-term mortgage rates. In fact, this is what the Federal Reserve did during the financial crisis of 2008 and 2009 to stimulate the housing market with lower rates on 30-year loans. The program allowed the Fed to spend hundreds of billions of dollars on these securities. Partly as a result, mortgage rates were at record lows at the end of 2009.