July 31, 2017 | Michael Gliottone
The Federal Reserve Open Market Committe (FOMC) meets at least eight times per year to discuss and vote on US monetary policy. The Fed controls the Fed Funds rate, which is essentially a bank's cost of borrowing money. When the Fed increases the Fed Funds rate, short-term interest rates such as the Prime rate and LIBOR go up. These are often used to determine interest rates on adjustable rate mortgages, home equity lines of credit, credit card balances, and business loans.

However, interest rates on fixed-rate mortgages are not tied to changes in the Fed Funds rate. Mortgage rates are determined by the supply and demand for mortgage bonds in the bond market. When you get a mortgage in the US, your mortgage company is getting the money from Fannie Mae, Freddie Mac or other "securitizers". These securitizers get their money by issuing bonds to bond market investors. These bonds are called "mortgage bonds" or "mortgage backed securities". Therefore, the mortgage rate you pay is really determined by the supply and demand for mortgage bonds in the bond market. Before the housing crisis in 2008 the Fed owned $0 in mortgage bonds. However, once the financial crisis happened, the Fed began buying mortgage bonds to drive interest rates lower and stimulate the economy. Presently, the Fed owns a whopping $1.75 TRILLION in mortgage bonds!

In fact, the Fed has been the biggest buyer of mortgage bonds in recent years. However, the Fed has indicated that at some point, they will slow down or stop their purchase of mortgage bonds. Currently, the market is thinking this will happen sometime toward the end of 2017 or beginning of 2018. Market expectations can change at a moment’s notice though. That's why it's not cut and dry how mortgage rates will respond as the Fed changes, or doesn't change the Fed Funds Rate.


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