At this week’s Federal Open Market Committee meeting, the nation’s central bank will carry out its final monetary policy decision of 2023. After spending much of the last two years aggressively hiking the federal funds rate from near zero to between 5.25% and 5.50%, the Federal Reserve is expected to hold interest rates steady for a third consecutive time. 

While rate hikes have succeeded in cooling down inflation, they’ve also resulted in increased costs to borrowers. Those rate bumps also had an adverse effect on the housing market, helping to drive mortgage rates to levels as high as 8%. 

Wednesday’s decision by the Federal Reserve, together with last week’s labor data and today’s inflation data, will play a major role in determining the direction of mortgage rates in the coming months. Fundamentally, it could signal good news for homebuyers, who are hoping the recent dip in mortgage rates will turn into a sustained downward trend in 2024. 

Here’s what to know about how the Fed’s decision impacts mortgage rates. 

Read more: What Lower Mortgage Rates Mean for the Holiday Homebuying Season

What does the Federal Reserve do?

The Fed was established by the 1913 Federal Reserve Act to set and oversee US monetary policy to stabilize the economy. Consisting of 12 regional banks and 24 branches, it is run by a board of governors who are voting members of the Federal Open Market Committee. The FOMC sets the benchmark interest rate at which banks borrow and lend their money. 

In an inflationary environment like today’s, the Fed uses interest rate hikes to make borrowing money more cost-prohibitive and slow economic growth. Banks typically pass along rate hikes to consumers in the form of higher interest rates for longer-term loans, including home loans. 

How does the federal funds rate impact mortgage interest rates? 

While the Federal Reserve bank doesn’t directly set mortgage rates, it influences them by making changes to the federal funds rate, the interest rate that banks charge each other for short-term loans. The Fed’s decisions alter the price of credit, which has a domino effect on mortgage rates and the broader housing market. 

“When the Fed raises interest rates to slow the economy, rate-sensitive sectors like tech, finance and housing typically feel the impact first,” said Alex Thomas, senior research analyst at John Burns Research and Consulting. 

It’s important to keep an eye on what the Fed does: Its decisions can affect your money in multiple ways, including the annual percentage rate on your credit cards, the yield on your savings accounts and even your stock market portfolio.

What factors affect mortgage rates?

Mortgage rates move around for many of the same reasons home prices do: supply, demand, inflation and even the employment rate. Additionally, the individual mortgage rate you qualify for is determined by personal factors, such as your credit score and loan amount.

Economic factors that impact the rates on mortgage loans

• Inflation: Generally, when inflation is high, mortgage rates tend to be high. Because inflation chips away at purchasing power, lenders set higher interest rates on loans to make up for that loss and ensure a profit.

• Policy changes from the Fed: When the Fed adjusts the federal funds rate, it spills over into many aspects of the economy, including mortgage rates. The federal funds rate affects how much it costs banks to borrow money, which in turn affects what banks charge consumers to make a profit. 

• Supply and demand: When demand for mortgages is high, lenders tend to raise interest rates. The reason is because lenders have only so much capital to lend out in the form of home loans. Conversely, when demand for mortgages is low, lenders slash interest rates in order to attract borrowers. 

• The bond market: Mortgage lenders peg fixed interest rates, like fixed-rate mortgages, to bond rates. Mortgage bonds, also called mortgage-backed securities, are bundles of mortgages sold to investors and are closely tied to the 10-Year Treasury. When bond interest rates are high, the bond has less value on the market where investors buy and sell securities, causing mortgage interest rates to go up. 

• Other economic indicators: Employment patterns and other aspects of the economy that affect investor confidence and consumer spending and borrowing also influence mortgage rates. For example, a strong jobs report and a robust economy could indicate greater demand for housing, which can put upward pressure on mortgage rates. When the economy slows and unemployment is high, mortgage rates tend to be lower.

Personal factors 

The specific factors that determine your particular mortgage interest rate include:

Will mortgage rates go down if the Fed stops hiking rates? 

Housing market authorities predict mortgage rates will begin a slow downward trajectory as we round the final bend of 2023. But we’re not likely to see any dramatic decline in rates — think below 6% — just yet. That’s because even though economic data shows signs of progress, the Fed won’t consider cutting rates until it feels confident that inflation is steady at its target annual rate of 2%. It might not be until mid-2024 when mortgage rates move closer to 6%.