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The Fed: What is it and how does it affect Your Mortgage?

It seems as if every few months your email inbox becomes inundated with the same type of vaguely ominous messages, warning you to “act fast before the Fed raises interest rates.”  These communications are followed closely by the talking heads on your local business or news show shouting out cautionary statements about how “the Fed is contemplating raising rates at their next meeting.”  In fact, as you read this attempt at a witty article, that oft repeated boogey man is making its way through the current news cycle.

While the attention grabbing headlines and audio clips may or may not induce you to action, it will also leave most people scratching their heads in confusion.  What is the Fed, what do they do, and what does the fact that they are meeting have to do with you buying a house right now anyways?  For answers to these questions and more, sit back and get comfy as we delve into the mysterious ways of the Fed.

Just What the Heck is the Fed Anyways?

The Federal Reserve System, also referred to as the Federal Reserve or the Fed, was created in 1913 when then president Woodrow Wilson signed the Federal Reserve Act.  The creation of the Fed was a response to a variety of financial market instabilities that caused large fluctuations in the stock markets, runs on major banks and wild swings in bank interest rates.  The federal government thought these were horrible, awful, bad things, since interest rates and financial markets have a direct impact on the amount of money people can borrow, the price of debt used to finance major development and infrastructure projects and companies’ general outlook on business and hiring practices, among other things.

So out of these uncertainties, the Fed was created.  Per their handy informative government funded website, the Fed’s stated mission includes four main areas of responsibility.  These include: conducting the nation’s monetary policy in pursuit of full employment and stable prices, monitor banks to ensure the soundness of the nation’s banking and financial systems, maintain the stability of the financial system and provide a number of financial services to the U.S. government and its financial institutions (in other words do bank stuff).

How the Fed Affects Mortgage Interest Rates

So now that we know the what, we should talk about the how.  The Fed effectively sets the federal funds rate by increasing or lowering the amount of Treasury bonds it buys.  In order to buy bonds, the Fed must print money.  While the process gets convoluted here, let’s just say that printing more or less money has certain financial impacts on the major banks that causes them to change the interest rate that they charge to each other for short term lending (that whole federal funds rate we mentioned before).

You will often hear the talking heads mention that the Fed has “targeted” a certain rate.  This is because the Fed doesn’t actually increase or lower the federal funds rate, they just take certain actions that would impact it.  The Fed has a Board of Governors that help set policy and a Federal Open Market Committee that is comprised of some pretty financial smart individuals.  They look at various data compiled regarding employment rates, inflation, consumer spending and confidence and other key statistics and decide what actions they need to take to get the federal funds rate to a certain number, based on whether they think lending and borrowing should be encouraged or discouraged.

Pretty much all interest rates charged for borrowing money, whether it be a car loan, the APR on your credit card or the mortgage interest rate your bank sets on your loan for that home purchase, are derivative of the fed funds rate.  Therefore, when the fed acts, mortgage interest rates go up or down in response.

Do You Really Need to Act NOW?

If you have been following along you now know who the Fed is, what they do and how they don’t actually use black magic mumbo jumbo to do it.  The question is, should you really be concerned if the Fed is considering taking actions that will raise or lower the interest rate on your potential mortgage.  The answer is: it depends.

While mortgage rates continue to hover around near record lows, historically the Fed only takes small actions in either direction, when they do take any action at all that is.  This is because wide swings are generally bad for the economy.  So if you haven’t found that perfect home yet, don’t settle for one that you hate just because rates may go up by a quarter of a point in a few months.  Also, rates historically vary over a period of years, seeing valleys and hills along the way.  If you end up with a slightly higher interest rate now, you may be able to refinance into a lower rate at a later date.

Finally, a little research can go a long way when it comes to your interest rate.  Major financial news outlets are full of predictions about what the Fed will do in their next meeting and any large swings would be widely talked about ahead of time.  In other words, those emails that sounds like sales pitches preaching doom and gloom probably are just sales pitches, so take their info with a “pinch of salt” as my mom would say.

We hope we have armed you with the knowledge you need to help decide whether now is the right time to act on buying a new home, or at least impress friends at your next dinner party.  In the end, a house is more than a financial investment; it’s a home and a major life decision that should be influenced by more than a .25% shift in interest rates.

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