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Do Mortgage Interest Rates Move In Proportion To The Fed Rate?

By Stacy Williams

While mortgage interest rates are all long term, the Fed rate, or as called in its full length–the Federal Funds rate, is of the shortest among all; it is the rate charged by banks for lending to each other over night. Banks as regulated by the Federal Reserve are required to maintain, out of their total deposits, certain amount of reserve with the Fed, as a means to control the entire lending capacity upon the economy from the banking industry and also a way of providing margins of safety against potential lending losses for individual banks.

Bank Reserves and the Bank Rate

Depending on the level of the total deposits and total lending, which all change from time to time, banks may find themselves having excess reserves at the Fed sometimes and deficient reserves other times and adjustments need to be made. The best way to lend out the excess and borrow in for the deficiency is for banks to make reserve lending arrangements between each other to settle on the Fed requirements at the end of the day. And the rate used for those reserve lending is set by the Federal Reserve known as the Fed rate.

Mortgage Interest Rates and a Higher Fed Rate

If the rate for borrowing from each other over night to settle the reserve mandate is too high, banks with deficient reserve would not want to borrow from its fellow banks and rather choose to lower its lending capacity by reducing outstanding loan amount. For those with excess reserve, if there is any banks still in need of borrowing to meet reserve requirement, they would be willing to lend over night at the higher Fed rate as opposed to making riskier commercial loans. Or else, the Fed would pay banks interests on excess reserves. All the actions triggered by the higher Fed rate help restrict the total amount of lending available in the economy, mortgage loans included and therefore potentially and indirectly increase lending rates, as well as mortgage interest rates.

Mortgage Interest Rates and a Lower Fed Rate

When the rate for reserve lending is too low, banks with excess reserves would rather lend them out as commercial loans at higher rates, rather than lending to other banks for an over night low rate. On the other hand, banks with deficient reserves must have really expanded their lending activities without the concerns about meeting reserve requirements as the cost for reserve borrowing is so low. There are always some banks with excess reserve that other banks in need of reserves can go to. Or else, the Fed could even lower reserve requirement in a low rate environment to further stimulate banks’ lending efforts. All actions taken together as results of a lower Fed rate help expand total bank lending, mortgage loans included and likely lower mortgage interest rates. Although Mortgage interest rates do not move in proportion to the Fed rate, they are indirectly affected by the Fed rate and most likely move with it in the same direction.

Related posts:

1. Is The FED Having Less Influence Over Mortgage Interest Rates?
2. Does The Prime Rate Affect Mortgage Rates?
3. Why Do Mortgage Rates Vary From Bank To Bank?
4. How Do Federal Rate Cuts Affect Mortgage Refinance?
5. What Interest Rates Determine Mortgage Rates?