Who changes the interest rates?

Posted July 10, 2023

The Federal Reserve manipulates interest rates, but there are a lot of moving parts to exactly how that happens. You don't have time to read all those factors. In theory, the Federal Reserve doesn't directly change mortgage interest rates, but they do directly influence when they change and if interest rates go up or down. The Federal Reserve does have omnipotent power to influence all types of interest rates. Mortgage rates can also temporarily be influenced by what the Federal Reserve says it will do through Federal Reserve meetings and during random press releases, that seem are meant to test the waters of public opinion and what the stock market does.

In practice, the Fed controls when and how much they raise or lower mortgage and other long and short term rates by adjusting the Federal Funds Rate, also known as the "overnight rate". This is obviously a major factor in changing long term mortgage interest rates. When the Fed feels like the economy is doing well and inflation starts to rise due to various other economic factors, they try to raise interest rates to slow down the economy, which theoretically tempers excessive overborrowing by Wall Street, consumers, and the Commercial sector. Conversely, as in the case of the Covid-19 Pandemic, the Fed felt they needed to stimulate the economy, so they lowered the Federal Funds Rate to the lowest in history. As of late December 2021, they are discussing raising interest rates to curb the recent high inflation rate.

The inflation in late December 2021 is the highest its been since the early 1980's. According to Freddie Mac in October 1981 residential mortgage rates were 18.45% to purchase a home. If the inflation rates were that high back then, does that mean mortgage rates will go back up to that level again? Remember, inflation is caused by excessive government spending, high food and energy costs. Thats what happened in the early 80's. Does that sound familiar in late 2021?

In March of 2020, the Federal Reserve brought the Federal Funds Rate down to 0.00% from 0.25%. This caused short-term and long term interest rates to drop. According to Freddie Mac, (the Government Sponsored Entity) December 2020 saw mortgage rates (2.68%) at their lowest point in history. Whether the consumer was a First Time Home Buyer or a Wall Street Hedge Fund, this seemed like a win-win for everyone. Unfortunately, due to historically low mortgage interest rates, this decision started a residential home buying frenzy. This caused residential home prices to dramatically increase, and housing became overpriced and over-valued. In 2020 - 2021 many First Time Home Buyers could no longer afford to purchase homes because, in several southern states, residential housing had artificially appreciated by almost 35% in that 2 year period. A single family home that was priced at $200,000 in late 2019 became overvalued in late 2021 to a purchase price of $270,000! That housing "appreciation" rate has never happened before in the United States.

It seems that too much of a good thing turned bad for southern First Time Home Buyers. Much of the rest of the country, real estate values also increased, but not quite that much. Would it have mattered if the mortgage interest rates were raised back in January of 2021 when the pandemic seemed to stall and the economy was clearly in recovery mode? Maybe, but that's above my pay grade.

Article by R. Lazzarino, Florida Down Payment Assistance & Real Estate Expert