What is the fed funds rate?
The federal funds rate is the interest rate U.S. banks charge each other for overnight loans, and it has significant economic implications. As the nation’s central bank, the Federal Reserve sets this rate to help balance two primary economic objectives: controlling inflation and maximizing job growth.
Eight times a year, the Federal Open Market Committee (FOMC) meets to discuss the economic outlook and adjust the federal funds rate accordingly. By controlling this rate, the Federal Reserve influences the cost of borrowing across the entire economy, including current mortgage interest rates.
When the Fed raises rates, borrowing gets more expensive. The banks usually pass on the extra expense to consumers, charging higher interest for loans and credit. This tends to slow consumer spending and business expansion, which ends up cooling demand and curbing inflation. Conversely, Fed rate cuts make borrowing cheaper, which can encourage consumer spending and economic growth to help heat up the job market. These moves impact everything from credit cards to business loans and, indirectly, mortgage rates, too.
How the Fed rate influences mortgage rates
It’s a common misconception that mortgage rates drop immediately after a Fed interest rate cut. In reality, it’s more like setting a thermostat for the entire economy. The Fed rate sets the overall “climate,” but mortgage rates are shaped by a mix of other conditions.
PRO TIP
Don’t assume that mortgage rates will fall the same day the Fed cuts rates. Sometimes, they don’t end up falling at all. Stay updated by checking current mortgage rates regularly and be ready to act if the timing is right.
Here’s how it works:
- Fixed-rate mortgages are also tied to long-term bond yields, particularly the 10-year Treasury yield. When investors expect slower economic growth, bond yields may fall, and mortgage rates often follow.
- Adjustable-rate mortgages (ARMs) and home equity lines of credit (HELOCs) respond more directly. These loans are based on short-term interest rates and indexes—like the prime rate or Secured Overnight Financing Rate (SOFR)—which closely track Fed actions. That means you might see lower payments on ARMs and HELOCs more quickly than on fixed-rate mortgages, although the timing can vary with each loan and lender.
Why mortgage rates don’t always fall after a Fed cut
In theory, Fed interest rate cuts should make mortgages cheaper. But in practice, other economic forces can keep mortgage rates high even when the Fed is easing policy. We saw this happen at the end of 2024; even after three rate cuts, the average rate on a 30-year mortgage rose above 7% by mid-January. So, what else could be happening behind the scenes?
- Market expectations
If a rate cut is widely expected, mortgage rates may adjust in anticipation of the official announcement. - Long-term vs. short-term rates
Fed rate cuts impact short-term rates more directly. Since fixed mortgage rates are tied to long-term rates like the 10-year Treasury yield, they may not drop. - Economic outlook
If a rate cut signals a weaker economy, lenders may worry about more people defaulting on loans. To protect themselves, they might charge extra fees, known as risk premiums, which can keep mortgage rates from dropping even after a rate cut. - Inflation expectations
If investors think that rate cuts could fuel inflation, mortgage rates might actually go up. That’s because lenders want to make sure they’re still earning a profit even if rising prices reduce the value of future payments. To protect themselves, they may raise interest rates to keep up with the expected cost of inflation. - Supply and demand for mortgage-backed securities
If fewer investors are buying mortgage-backed securities or there are a lot more of them available, mortgage rates might not go down even if the Fed cuts rates. Instead, rates could stay the same or even rise because lenders need to offer higher returns to attract buyers.
What a Fed rate cut could mean for borrowers
After that crash course in economics, you’re probably ready to cut to the chase—how should you react to the federal funds rate today?
- Potential home buyers
Lower rates can make monthly payments more affordable, but don’t expect instant savings. Mortgage rates may take time to fall, and in some cases, they might not drop at all. In the meantime, focus on what you can control: your financial stats. Make sure your credit score, debt-to-income (DTI) ratio and down payment funds are in good shape, because a creditworthy financial profile can help you earn better terms and a lower interest rate. - Refinancers
If you’re considering a mortgage refinance, a Fed rate cut can sometimes help you save more. If rates drop far enough, refinancing to a lower rate could mean smaller monthly payments and less interest paid overall. As a rule of thumb, consider refinancing if you can lower your interest rate by at least 1% and you plan to stay in your home long enough to recoup closing costs. If rates don't drop right away, patience may pay off. Keep monitoring the market and be ready to move when the numbers make sense.
PRO TIP
If you're considering refinancing but can't decide, this guide can help you weigh the pros and cons to make an informed choice.
- Home equity (HELOC) borrowers
HELOC rates adjust based on the prime rate, which follows the Fed’s moves closely. So, when the Fed cuts rates, HELOC borrowers may see lower interest costs and smaller monthly payments relatively quickly. But timing still varies by lender. If you have a HELOC, keep track of your statement rate and ask your lender how quickly changes are applied. While the Federal Reserve’s rate cuts may open the door to potential savings and better borrowing opportunities, the real impact depends on current mortgage rates, timing, market conditions and your financial readiness. Whether you're buying a home, refinancing or managing a HELOC, staying informed and maintaining a strong financial profile are key to maximizing your benefits in a changing rate environment.
