Feds announce rate hikes – what does that mean for you?

On March 16th the Federal Reserve is set to meet to discuss a possible change in the federal interest rates. Speculation says that they will likely agree to increase the rate during the meeting.

There’s a lot of misunderstanding out there about what the federal interest rate does, and what it means for everyday consumers. The important thing to note is that a raise in federal interest rates does not necessarily mean a direct raise in the mortgage rates. Here’s a background on the federal interest rates, and what a change could really mean for you.

Understanding Federal Interest Rates

When the media talks about federal interest rates, they are usually talking about the federal funds target rate. The federal rates are determined by the Federal Open Market Committee, which meets various times throughout the year.

The federal rates set guidelines for the interest rates that banking institutions should loan money to each other.

Bank Reserves and Federal Rates

Bank reserves are how much money a bank has on hand. Bank reserves are regulated by federal law and determined by the size of the bank. Law requires that banks hold a certain amount of money in reserves. Meaning, they must keep a minimum amount on hand and are not able to lend it out to consumers.

If a bank goes below the minimum set by federal law, then they look to other banks or financial institutions, usually with higher reserves, to borrow from. When one bank borrows from another, it is at an agreed upon interest rate, negotiated by the banks themselves.

The Federal Reserve sets the federal funds target rate as a guideline for the interest rate that banks to lend to each other. The actual rate is usually within a range of the target rate.

What this means for mortgage rates and consumers

A major misconception is that the Feds increasing the rates means that they are increasing mortgage rates. This simply is not true. As you see from above, the rate change is directly on institutions, not on consumers or homebuyers. It also is not a direct change in the interest rates that financial institutions offer on their mortgage loans.

The mortgage rates that a bank offers on their loans could increase a little as a result of the federal rates increasing, but it is not a direct correlation. It also may not necessarily be right away.