The Federal Reserve is done hiking interest rates — for now. Here’s what that means for mortgage rates. 

Since March 2022, the Fed has increased its benchmark federal funds rate from near zero to a range of 5.00% to 5.25%. It’s all been in the name of taming inflation. In response, inflation — which was at 4.0% in May — has been slowly but steadily declining from its peak last summer. 

Although the Fed doesn’t directly set mortgage rates, it nevertheless plays an influential role. Mortgage rates respond to several economic factors including inflation, the strength of the labor market and the Fed’s monetary policy, which is established by the Federal Open Market Committee. 

While inflation is still well above the Fed’s 2% target, the central bank has decided to pump the brakes on bumping up rates. Instead, the Fed will hold rates where they are and watch how inflation and the economy responds. 

This doesn’t mean the Fed will cut rates any time soon, but some of the current upward pressure on mortgage rates may ease. 

“Ultimately, more certainty about the Fed’s actions will help to smooth out some of the volatility we’ve seen with mortgage rates,” says Odeta Kushi, deputy chief economist at First American Financial Corporation.

What is the role of the Federal Reserve?

The Federal Reserve is the nation’s central bank. Consisting of 12 regional banks and 24 branches, the Fed is run by a board of governors who are voting members of the FOMC. 

The FOMC is responsible for setting overall monetary policy, with the goal of stabilizing the economy and its growth. It does so, in part, by setting the federal funds rate, the benchmark interest rate at which banks borrow and lend their money. 

In an inflationary environment, like the one we’re in today, the Fed utilizes rate hikes to make borrowing money more cost-prohibitive for both banks and people. Banks typically pass along rate hikes to people in the form of higher interest rates for longer-term loans, including mortgages. That has an impact on prospective homebuyers. 

“Compared to a year ago, homebuyers are dealing with a much higher cost of ownership, due to the combination of higher mortgage rates, persistently high home prices and limited inventory,” says Nathan Anderson, director of consumer lending and product management at BMO Harris Bank. “These combined factors hurt home affordability.”

Factors that influence mortgage rates

Mortgage rates can vary from hour to hour and from person to person. What the Fed does matters, but many other factors play a role in determining what mortgage rates are available to you.

The Fed’s decision to pause rate hikes in June won’t have a direct impact on mortgage rates. Instead, mortgage rates will respond to changing expectations of inflation, interest rates and the broader economic outlook. 

Macro factors 

In addition to Fed policies, persistent inflation and the strength of the job market all point to mortgage rates near their highest levels in two decades. Though rates have dropped a bit, they’re still well above pre-pandemic lows. 

Although the Fed decided to pause rate hikes in June, that doesn’t mean mortgage rates will do the same. Experts say other factors like inflation and the broader economic outlook will continue to sway mortgage rates. 

“Rates are getting to a point of being steady. So, it’s more a question of how long it will take for rates to start ticking back down and when inflation will return to a place where your dollar starts buying a little bit more each month,” says Kevin Williams, founder of Full Life Financial Planning.

Micro factors 

But there are other factors that affect mortgage rates. When loan volume slows, lenders slash rates and loosen their credit requirements. Borrowers with a subpar credit score may actually have a better chance to qualify for a mortgage in a higher rate environment. 

When it comes to how a bank decides to make a loan, macroeconomic factors are only one part of the equation. There are a handful of much more specific factors that determine your particular mortgage interest rate. These include:

• Your credit score
• The home’s location 
• The home’s price 
• Your down payment
• The loan amount
• The loan type and term
• The type of interest rate

How the Fed’s decisions influence mortgage rates

The Fed may not set mortgage rates directly, but its decisions about the federal funds rate eventually affects mortgage rates and the broader housing market. 

When the Fed makes borrowing more expensive, fewer people borrow — which is what the Fed wants. That tamps down demand for goods and services, including homes. And that’s why there’s a potential silver lining in today’s elevated rates for some prospective homebuyers. 

Depending on where you’re located, home prices have been slowly, but steadily, declining, in response to high mortgage rates pouring cold water on home-buying demand. In April, the median US home sale price fell by 4.1% compared to last year, to $407,415, according to real estate brokerage Redfin. 

Falling home prices help matters a bit, but mortgage rates still hold the key to affordability. 

“Buyers should consider any mortgage they take today as an interim mortgage that they’ll refinance,” says Melissa Cohn, regional vice president at William Raveis Mortgage. “No one can guarantee how low rates will go, but they will be lower.” 

Going forward, mortgage movement will largely depend on the trajectory of inflation. If the Fed’s rate hiking measures prove to be successful in bringing inflation down to the 2% target, mortgage rates could see some declines towards the end of 2023. The average rate for a 30-year fixed-mortgage may fall close to 6.0% by the end of the year, according to the most recent housing forecast from Fannie Mae.

Things to consider if you’re shopping for a mortgage

Higher mortgage rates have taken a tremendous toll on many borrowers. “The increases in mortgage rates since the beginning of 2022 has been equivalent to more than a 32% increase in home prices — and that’s on top of the already heady appreciation seen in the past couple of years,” says Greg McBride, chief financial analyst at Bankrate, CNET’s sister site. 

Although it’s tempting to wait out higher mortgage rates with talk of a potential recession on the horizon, it’s risky to try to time the market and wait for mortgage rates or home prices to drop. Even if home prices depreciate, elevated mortgage rates could still leave you with a higher monthly mortgage payment despite getting a good deal on your home. 

“People are better off buying in an elevated rate environment when there is less competition because when rates go back below 5% again, there will be a lot more competition for whatever existing inventory there is,” Cohn says.  

Regardless of what’s happening with the economy, the most important thing to consider when shopping for a mortgage is making sure that you can comfortably afford your monthly payments.

“From a financial perspective, the decision to buy a home comes down to a payment-to-paycheck calculation, which is influenced by income, mortgage rates and house prices,” Kushi says.

Keeping your day-to-day financial life healthy is what matters the most when making a significant financial decision such as buying your first home. Make sure to always shop around and compare mortgage lenders to ensure you’re getting the best rates and terms available to you.

How rising interest rates affect your home equity

If you already own a home, mortgage rate fluctuations won’t affect you as much as borrowers applying for a new mortgage. But they can affect your home equity. Despite slight decrease in home prices though, homeowners are retaining high levels of tappable equity in their homes. 

“Typically, as rates go up, you start to see the valuations of real estate go down because the economy starts to slow up pretty quickly,” says Scott Lindner, national sales director for mortgage lending at TD Bank. “What we’re seeing here is a continued firmness of the value of real estate, so it’s not going up, but it’s not dropping significantly. That’s primarily because there’s a lack of inventory,” Lindner adds.

As a homeowner, keep in mind that although mortgage rates may not directly affect you, if you’re trying to sell your home, higher rates could limit the number of would-be homebuyers in your local market. 

What’s more significant for homeowners shopping for home equity loans and home equity lines of credit, or HELOCs, is the prime rate — another baseline rate banks use for lending. With mortgage rates above 6%, a cash-out refinance likely won’t make financial sense for most homeowners who already locked in lower mortgage rates during the pandemic.

In a rising interest rate environment, home equity loans and HELOCs can be a good option for financing. You can borrow against your home equity at a relatively low interest rate, and with a home equity loan, you can lock in a fixed interest rate — meaning your monthly payments will remain the same even if rates rise. 

However, home equity loans and HELOCs come with a risk. Since these loans are secured loans, you run the risk of losing your home if you default on your monthly payments for any reason.

First published on Sept. 20, 2022 at 12:48 p.m. PT.